How to Consolidate Debt: Best Options to Consider

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Figuring out how to consolidate your debt can be frustrating. Thankfully, when you're ready to start paying down your debt, including credit card and loan debt, you'll have many options to help you achieve your goal. Often, consolidating your debt will give you a leg up, as it reduces the number of payments you have to keep track of each month and could reduce the amount of interest you pay.

Best Ways to Consolidate Debt

While there are many ways to consolidate debt, the best option for you depends on your financial situation and the type of debt that you have. Whether you're looking for credit card debt consolidation or bill consolidation from a mixture of loan products, here are some best debt consolidation options to consider.

Balance Transfer Credit Cards

Balance transfer credit cards often offer a 0% promotional annual percentage rate (APR) for up to 21 months, making it a great way to pay down your debt without paying interest. You may have to pay a balance transfer fee of 3% to 5% of the balance, but the 0% APR could more than make up for any fee. Balance transfer credit cards can help borrowers consolidate credit cards and other loans, however, keep in mind that some lenders don't allow you to use this method of consolidation.

Similar to any form of debt, balance transfer credit cards have their drawbacks. If you aren't able to pay off the balance before the promotional period ends, or you make a late payment, you could be subject to regular credit card interest rates. This could end up costing more than other debt consolidation options.

Best for: people with excellent credit who can pay off their consolidated credit card and loan balances before the promotional period ends.

Personal Loans

Unsecured personal loans offer a straightforward way to consolidate your debt and will usually lower your interest rate at the same time. As with most loans, you can expect a lower interest rate if you have a higher credit score. People with excellent credit will generally receive a lower interest rate on a personal loan than they would on a credit card. So, if you're not sure that you can pay off your balance before the promotional period ends with balance transfer credit cards, taking out a personal loan may be a better option, depending on the interest rate you're offered.

Lower interest rates, combined with a fixed repayment period of one to seven years, allow you to potentially pay less in interest over the length of the loan. The shorter term could help you pay off your loan and credit card debt faster. However, even though interest rates on personal loans may be lower than some other options, a decent amount will go toward interest if your rate is 10% or higher.

Best for: people who don't qualify for promotional balance transfer credit cards or can't repay their balance before the promotional period ends.

Home Equity Loan or Line of Credit

Using the equity in your home to consolidate your debt with a home equity line of credit or home equity loan can be risky—but also worthwhile. Interest rates on home equity loans and lines of credit are lower than personal loans. If you use these low interest rates to your advantage and pay off the loan in the same number of years you would with a personal loan, you will likely pay less in interest. That said, the lender could foreclose on your home if you default on the loan.

Additionally, home equity loans and lines of credit usually have longer repayment periods, often 10 years or longer. More of your minimum monthly payment will go toward paying interest in the beginning of a long-term loan versus a short-term loan. You may end up paying more in interest even though you secure a lower interest rate. Thankfully, you can pay off the loan early to lower the amount of interest you'll pay. Just be careful; some home equity loans or lines of credit come with prepayment penalties if you pay off your debt within the first few years. Finally, keep this in mind: If you start incurring consumer debt again, you may not have your home equity to bail you out next time.

Best for: people with equity in their homes who are willing to make extra payments toward the loan, can make payments on time and won't rack up debt again.

Credit Counseling

Credit counseling can offer a variety of options to help you consolidate credit card and loan debt. You'll have to give the credit counselor access to information about your debt, income, expenses and any assets you may have that could be used to pay off your debt. Based on this information, the counselor will come up with a plan for the best way to consolidate credit debt and other loan debt.

Unfortunately, not all credit counselors are created equal. Some counselors work on commission and may try to sell you services you don't need. However, if you work with a National Foundation for Credit Counseling certified consumer credit counselor, you may have access to many services for free or for a low fee.

Credit counselors may offer solutions that include budgeting, consolidating debt, starting a debt management plan or even applying for bankruptcy in worst-case scenarios. It never hurts to compare their recommendations with options you've researched yourself to make sure you're getting the best deal possible, especially when it comes to debt consolidation loans.

Best for: people who don't know how to turn their finances around and are having trouble getting started on paying off their debt.

Last-Resort Options

If you have tried everything and can't seem to pay down your debt, there are options other than debt consolidation to consider. Keep in mind that these debt payoff methods should only be used as a last resort when you have no other options.

Bankruptcy

Filing for bankruptcy should not be taken lightly, as it will drastically lower your credit score and hurt your ability to obtain new credit in the future. Even so, bankruptcy is a legitimate option for people who have more debt than they can handle. Depending on the type of bankruptcy you apply for, you can either eliminate your debt or make the payments more manageable.

Best for: people who can no longer make their minimum payments each month, or owe more in "bad" debt (e.g., credit cards, personal loans, etc.) than their annual income.

401(k) Loans or Life Insurance Policy Loans

Using a 401(k) loan or life insurance policy loan may help you pay off your debt, but they may create other financial issues. Borrowing from your 401(k) or life insurance policy reduces the money you've set aside to cover your retirement or help your loved ones deal with your unexpected death. Furthermore, if you can't pay back your 401(k) loan on time, it could be considered a taxable distribution, resulting in tax penalties. And life insurance loans that aren't paid back could result in less money for your family after your death.

Best for: These loans are only acceptable as a last resort when you've exhausted all other debt consolidation options and you have extremely high interest rates (30% or higher) or tax debt.

Options to Avoid

While these options will technically help you pay off debt, they'll hurt your finances in the long run. Avoid these methods when possible.

Debt settlement: Under this method, you'll arrange to pay less than you owe to your creditors, but it can hurt your financial future. Creditors will typically accept debt settlement only after you stop making payments, which can significantly damage your credit score for several years. Additionally, if you work with a debt settlement company, its fee may eat away at some of the savings you'd get from settling your debt. Furthermore, you may owe taxes on any forgiven debt. The downsides of debt settlement make it an option you'll want to avoid.

Payday loans, no-credit-check loans and title loans: The extremely high interest rates and strict terms that are usually associated with these types of loans make it practically impossible to save money. In fact, these should be at the top of the list of loans you want to eliminate when you're consolidating debt.

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