When debt gets hard to handle, find the right financial tools to help you take control and get out of the red.
What is debt consolidation?
Debt consolidation, sometimes called credit consolidation, involves merging multiple debts into a single debt. It can make things easier, and maybe even less expensive, for borrowers like you to pay off debts.
You can use consolidation to clear up different kinds of debt, including:
- Credit cards
- Medical expenses
- Retail store cards
- Personal loans
- Student loans
Consider the example of credit card debt. If you have credit card balances that keep you up at night, you’re not the only one tossing and turning. Less than 40% percent of American consumers pay their credit card bills in full every month, according to government research.
Running a balance on multiple credit cards can leave you constantly wondering, “Which card should I pay off first?” or “How much is this costing me in interest?”
Fortunately, you may be able to take control of multiple credit card balances and other debts by consolidating them. Just consider the pros and cons and then make an informed decision.
How do you benefit from consolidating debts?
It can have the immediate positive effect of helping you manage debt more effectively. In a broader sense, it can bring long-term benefits by improving your credit score.
The factors that credit bureaus look at when determining your score include credit utilization, the ratio between your available credit and the credit you’re currently using (credit card balances, mortgage, car loan, etc.). Experts recommending keeping the ratio at 30 percent or lower to show potential lenders that you can use your credit responsibly without getting overextended.
Which debts can you consolidate?
Although you can use debt consolidation for different purposes, it’s not an all-purpose solution.
It typically addresses unsecured consumer debt — debt that doesn’t require putting up property as security, as you would with an auto loan or a mortgage. If you have concerns about debt on a house or a car, you may need to look into an auto refinancing loan or a mortgage refinance.
Also, you may need a specific type of debt consolidation for particular situations, such as student loan consolidation.
Different methods of debt consolidation
You have more than one way to consolidate debt. Consider some of the financial tools you can choose from:
Debt consolidation loans
The typical debt consolidation loan is a personal loan that goes into action with three steps:
- The lender issues the loan in a single lump sum
- You use the money to pay off debts
- You replay the lender who issued the consolidation loan
Pros and cons:
- PRO: Debt consolidation loans offer the convenience of one monthly payment — no more tracking multiple statements and keeping track of which bill is due when.
- PRO: You could save considerable money by getting a loan with a lower interest rate than what you’re paying on the debts you want to consolidate.
- CON: Although possibly simpler and less costly, a debt consolidation loan is still a form of debt. You’ll need financial discipline to handle your consolidated debts responsibly.
Balance transfer credit cards
Credit card APR (annual percentage rate) combines interest, charges and fees. If you continuously run a large balance, APR could cost you a lot of money.
A balance transfer credit card lets you transfer outstanding credit card balances to the new card. Balance transfer cards often include special introductory offers for low or zero percent APR for a limited period, sometimes as long as 18 months.
Pros and cons
- PRO: A balance transfer card can offer relief from the costs of APR, even if only temporarily.
- PRO: Although rules vary by provider, many cards allow between two and five transfers.
- CON: When the introductory period ends, any balance you have on the transfer card will be subject to APR.
Home equity loan/line of credit
In some cases, you could use a different kind of loan — namely, a home equity loan (HEL) or home equity line of credit (HELOC). Although not called debt consolidation loans, they can be used to provide money for that purpose.
Pros and cons
- PRO: Home equity and a good credit score can help you get more affordable interest rates.
- PRO: The more equity you’ve built up in your home, the more money you may be able to borrow.
- CON: An HEL or HELOC requires using your house as collateral. Defaulting would put your house at risk of foreclosure.
Find your best way to get out of debt
Consolidating debt may not work for every situation. If debt has become serious enough to threaten your financial well-being, you may need to consider other options for getting out of debt.
However, if things like credit card balances and medical bills are just a problem and not a crisis, look into a debt consolidation strategy. Debt might be the only thing you have to lose.