Pros and Cons of Debt Consolidation

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If you’re grappling with mountains of debt from high-interest credit cards and loans, consolidating your debts could offer some much-needed relief. With debt consolidation, you bundle multiple outstanding debts into a new single loan. And while it might seem counterintuitive to take on a new obligation, debt consolidation can actually save you time and money.

If you’re struggling with debt, you’re not alone. The average American credit card debt is $5,700, and 41.2% of households carry some credit card debt, according to data compiled by ValuePenguin.

What you need to know:

  • Debt consolidation rolls outstanding debt into one new loan with a single monthly payment.
  • Depending on your financial history and credit score, options could include a personal loan, balance transfer credit card, home equity loan, home equity line of credit or debt management plan.
  • You may be able to lower your interest rate with debt consolidation.

In this article, we will review all of your options for debt consolidation and how to determine which product is best for you.

What is debt consolidation?

Debt consolidation is a broad term that is used to describe rolling several outstanding accounts into a new loan product such as a personal loan or balance transfer credit card. These usually feature a lower interest rate and require only making a single, monthly payment.

“When you can consolidate your debt like multiple credit cards or car loans into one loan, it can equal lower payments and you can pay it off faster,” explained R.J. Weiss, a certified financial planner and founder of “Ways to Wealth” blog. “These loans are best used in conjunction with a proactive approach to finances and the goal of paying off your debts as quickly as possible.”

It’s important to note that debt consolidation doesn’t erase your outstanding debt, and you’re still responsible to your creditors. It may simply lower your interest rate, and thus the overall cost of your debt in the long run. It may also make it easier to manage your debt because you only have to keep track of one monthly due date.

If you’re considering debt consolidation, here are some of the most popular options:

Personal loan

Available from many banks, credit unions and online lenders, a personal loan is a popular mode of debt consolidation. It allows you to roll multiple outstanding debts into a single loan. You’ll want to find a loan with a lower interest rate than you’re currently paying. (ValuePenguin features comparison rates on credit cards and personal loans.)

A personal loan can be secured by a hard asset, such as a car. That often gives you lower interest rates and more favorable terms. Unsecured loans, on the other hand, are not backed by any collateral. They’re considered higher risk to the lender and may come with higher rates — but you don’t have to worry about losing your property if you default.

Your credit score plays an important role in any personal loan application. The better your score, the better chances you have to qualify with the best terms.

Pros of a personal loan

  • Since personal loans often have lower interest rates than high-interest credit cards, you’ll likely save on interest charges.
  • With a single payment and lower interest charges, you may be able to pay back your loan faster and save money.
  • Since on-time payments are a factor in your credit score, if you pay your new loan regularly, your score could improve.

Cons of a personal loan

  • Some loans feature an introductory low interest rate, but that can increase significantly when the promotion expires.
  • Some lenders charge an origination fee for personal loans, which can be 1% to 6% (or more) of the loan amount.
  • If you want to pay off your loan ahead of schedule, there could be prepayment charges. Be sure to inquire about penalties.

Credit card balance transfer

It may seem unorthodox to apply for a new credit card to manage debt from your existing credit cards and other loans. But a balance transfer credit card could actually save you money.

Many balance transfer credit cards these days have no-interest introductory periods of more than a year. You can take your high-interest debt and transfer it to one balance transfer card with a single monthly payment. As long as you pay off the debt before the intro period ends, you could save a lot of money on interest.

Pros of a credit card balance transfer

  • By transferring your high-interest debt to a low- or zero-interest credit card, you can bundle outstanding debt into one payment.
  • During the introductory period, you can take advantage of paying down debt without incurring any additional interest.
  • You may qualify for perks or benefits from the new card, including cash rewards or airline miles.

Cons of a credit card balance transfer

  • You may pay a balance transfer fee (average: 3%) so check the fine print on the credit card offer.
  • Low or zero rates typically expire after an introductory period (six to 21 months), and then rates can increase significantly.
  • If you can’t make your payments or miss a payment by more than 60 days, your interest rate could go up significantly.

Home equity loan

If you own a home and have equity in your property, you may be able to put that equity to work to consolidate your debt. A home equity loan, also known as a second mortgage, takes the value you’ve accrued in your home by paying your mortgage and allows you to convert a portion into a lump-sum cash payment.

The loan is secured with property as a hard asset. “Because you’re putting up your home as collateral, you’ll often get the best interest rate, but if you can’t pay your loan, you risk losing your home,” Weiss said.

Pros of a home equity loan

  • With your home as collateral for your loan, you may qualify for a lower interest rate than the rate on an unsecured personal loan.
  • The interest rate and loan term are fixed, so you’ll have one set monthly payment, which could make it easier to budget.
  • Terms often run up to 30 years, allowing for lower monthly payments than shorter personal loans.

Cons of a home equity loan

  • Securing a loan with your home can be risky because if you default on your loan, your lender could foreclose on your property.
  • Since home equity loans provide you with a lump sum of cash, you will be limited to that amount. If you need more, you’ll have to apply for an additional loan.
  • You may need to pay closing costs on your home equity loan, which could run into the thousands of dollars.

Home equity line of credit

A home equity line of credit, or HELOC, is similar to a home equity loan in that it is backed by your home equity. But a HELOC is a revolving line of credit that you can draw on as needed. During the “draw period,” which is often 10 years, you can borrow against the line, repay what you borrowed and then borrow again. In that way, it’s like a credit card. Once the draw period ends, you can no longer borrow and must repay the principal and interest.

Pros of a HELOC

  • Because the loan is secured with your home, HELOCs often feature low introductory interest rates.
  • If you need access to more cash for emergencies or other expenses — and you have credit remaining on your HELOC — you can still tap into additional funds.

Cons of a HELOC

  • Like a home equity loan, you’re putting up your home as collateral. If you fail to make payments on time, you could be risking your home.
  • Most have variable interest rates and if they increase, your monthly payments could go up.

Debt management plan

For individuals who don’t qualify for a debt consolidation loan, a debt management plan might be an alternative worth investigating. With a debt management plan, a nonprofit credit counseling agency works with your creditors to try to lower your interest rates, and combines your debts into a single monthly payment. You pay the counseling agency and they pay your creditors. A debt management plan is not a loan, but rather a program to manage and pay down debt.

It may be easy to confuse debt management with “debt relief” or “debt settlement” services. They’re not the same. With debt settlement, you pay less than what you owe in a process that severely harms your credit. To find a nonprofit firm that offers low-fee credit counseling and debt management, check the National Foundation for Credit Counseling and the Financial Counseling Association of America.

Pros of a debt management plan

  • You’ll consolidate your debts into a single, affordable monthly payment that is administered by the program.
  • You’ll have access to advice on debt management and budgeting.
  • Available for individuals who have poor credit or are denied other loan products.
  • Fees are low if you use a nonprofit credit counselor.

Cons of a debt management plan

  • As part of your settlement, you may have to close all your credit cards, which could lower your credit score.
  • Your participation will be noted in your credit report and lenders will usually not issue you new credit until you complete the program.

Summary of Debt Consolidation Options

FeesEligibility RequirementsTypical Length of Repayment Term
Personal loanSome banks charge origination or closing fees. Others, like Wells Fargo, advertise no-fee loans.Credit score, payment history and income. Credit score typically must be above 650. Scores above 720 will get the best terms.1-7 years.
Balance transfer credit cardPossible balance transfer fee, typically 3%.Credit score as low as 580, but scores above 740 will secure lowest interest rates.No set schedule, but introductory period may range from 6 to 21 months.
Home equity loanClosing costs that could range from 2-5% of the loan amount.Sufficient equity to cover your loan. Most lenders will not allow loans to exceed 80% of home value, and require a 680 credit score.5, 10 or 15 years.
Home equity line of creditMany banks and credit unions, including Bank of America and Alliant Credit Union, advertise no fees, but inquire with lender.Sufficient equity to cover your loan. Most lenders will not allow loans to exceed 80% of home value, and require a 680 credit score.5-20 years.
Debt management planMost agencies charge a monthly administration fee. Setup fees could run $75 and monthly fees up to $55.You must close down existing credit accounts and avoid new credit during your plan terms.3-5 years.

The bottom line

While mounting debt can be overwhelming, for some consumers, debt consolidation can offer both financial relief and a chance to start fresh. Since debt consolidation loans and balance transfer credit cards often feature lower interest rates than regular credit cards, you may be able to save money in the long term. Also, managing one monthly payment compared with multiple bills can reduce your stress and help you get organized.

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The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.