What Is Debt Consolidation and How Does It Work? (2024 Guide) (2024)

How Does Debt Consolidation Work?

There are several different ways to consolidate debt, and each works slightly differently. These include using a:

  • Personal loan
  • Home equity loan
  • Balance transfer card

In each case, you’ll open the new account and use the money from your new loan to pay off your existing debts – like credit cards. That leaves you with a single loan and a single monthly payment. If the interest rate on your new loan is lower than what you’re currently paying on your credit cards or other debts, you can often save money in interest payments and pay off your debt more quickly.

Another benefit of debt consolidation is that it streamlines the repayment process. By putting your multiple debt obligations — all with varying interest rates, loan terms, principal amounts and payment due dates — and putting them together, you can better understand your financial responsibilities.

Pros and Cons of Debt Consolidation

Debt consolidation has some nuanced advantages and disadvantages, most of which are largely dependent upon the borrower’s creditworthiness and the lender’s offers and stipulations.

Pros of Debt Consolidation

  • One monthly payment: Debt consolidation gives you one due date to plan for and remember.
  • Lower interest rate: Your interest rate depends heavily on what you qualify for, but typically, debt consolidation options can carry lower interest rates than other consumer debts like credit cards.
  • Fixed interest rate: Debt consolidation options can typically come with a fixed interest rate, meaning the rate remains the same throughout the lifetime of the term.
  • Shorter repayment term: Simplifying your repayments can allow you to pay off your debt more quickly because of the reduced interest, especially if you choose a shorter loan term.

Cons of Debt Consolidation

  • Associated fees: Most consolidation options, both loans and balance transfer cards, can include origination or balance transfer fees, which should be considered when you apply.
  • It doesn’t address the root cause of your consumer debt: While debt consolidation can help you manage your current finances and provide some relief, it doesn’t address the reasons for your accumulated debt.
  • A temporary dip in your credit score: Applying for new credit typically impacts your credit score, making it dip temporarily.
  • Longer repayment term: If you’re consolidating a large amount of debt, you may opt for a longer repayment period to receive lower monthly payments. However, that means you’ll be paying for a longer period of time and may end up paying more in interest over the long run.

How To Consolidate Debt

You’re not alone if the debt consolidation process seems overly complicated. There are numerous considerations, but the process can be simplified using our suggestions below.

1. Assess Your Debt Situation

Before you can consolidate your debt, you must clearly understand where you’re starting from. Identifying your current debt status can increase your financial awareness and help you make informed decisions.

You can assess your current debt situation by:

  • Listing your debts: Create an exhaustive list of all your debts, including the principal balance, interest rate and monthly payment.
  • Obtaining a copy of your credit report: You can request a free copy of your credit report from each of the three major credit reporting bureaus once per year by visiting AnnualCreditReport.com. Your credit report is a comprehensive summary of your history with credit and can give you more insight into your debt situation.
  • Finding out your credit score: Your credit report does not typically include your credit score, a three-digit number summarizing your creditworthiness, and what many lenders consider when you apply for credit. You can typically acquire your credit score from one of your financial institutions or a credit score service.
  • Calculating your debt-to-income (DTI) ratio. This will show how much of your monthly income goes toward your debt repayments. You can calculate your DTI by dividing your total monthly debt payments by your gross monthly income and multiplying it by 100 to get a percentage. This is another key measure that lenders look at when deciding if you qualify for a loan.
  • Creating relevant financial goals: After laying out all of your debt obligations and how they compare to your monthly income, it’s time to create relevant financial goals. These goals can include a debt payoff timeline or insight into which debts you want to eliminate first.

2. Explore Debt Consolidation Options

After you have your debt consolidation goals in mind, you can start exploring the many different consolidation options to determine which one will benefit you the most. Some consolidation methods include:

Debt Consolidation Loans

This generally refers to personal loans used to help you consolidate your debt. These loans typically offer more favorable interest rates than credit cards, though your specific rate will depend on your credit score.

These loans are also usually unsecured — meaning you don’t need to put up any collateral — so securing a low rate will require a strong credit history and score.

Balance Transfer Credit Cards

If you’re juggling a lot of credit card debt with high-interest balances, a balance transfer credit card can provide you with a quick debt repayment solution.

For this method, it’s best to find a credit card with a favorable introductory period. This is where the borrower can typically enjoy a 0% annual percentage rate (APR) on the transferred, consolidated balance for a specified period (often 6-21 months), depending on the card.

Though you may be charged balance transfer fees — often a percentage of the transferred amount — the introductory period allows you to focus on paying off your principal balance while interest accrual is paused. Understand that regular interest will apply to any remaining balance once the 0% APR repayment period is over.

Home Equity Lines of Credit (HELOCs) and Home Equity Loans

Homeowners can utilize the equity they have built in their homes to consolidate their debt. Your home equity is calculated by subtracting your mortgage balance from the current appraised value of your home.

A HELOC provides homeowners with a revolving line of credit, similar to a credit card. You can spend from the account as many times as you like during the draw period, and typically only pay interest until you reach the repayment period. Then you’ll pay back the balance of what you spent.

By contrast, a home equity loan is a lump sum payment that typically has a fixed interest rate and repayment schedule. Finding the best home equity loan rate is essential and can significantly impact your finances for years.

Which Debt Consolidation Option Is Best for Me?

Before deciding on a debt consolidation option, it’s important to assess your creditworthiness and check your credit report for any errors that could be weighing down your score.

  • With excellent credit, you may be able to qualify for a personal loan with a low interest rate that’s ideal for consolidating your debt.
  • With fair credit, you may be able to qualify for a home equity loan at a reasonable rate if you’re a homeowner.
  • Consider a personal loan before a home equity loan — assuming you can get a good rate and can pay it off — so you don’t have to pledge your home as collateral, putting it at risk of foreclosure if you fail to make your payments.

Once you’ve assessed your current debts and credit, you can move on to searching for a lender.

Consider the proposed interest rate, repayment period, and other terms and conditions when looking at lender options. At this point in the process, you’ll just be sifting through promotional, advertised offers; the true offer will come after you’ve submitted your application to the lender.

Applying for Debt Consolidation

Follow these basic steps to apply for your debt consolidation solution:

  1. Figure out your bottom line: What’s the total amount you need to pay off all of your debt? Grab a copy of your latest credit report and all your outstanding credit card and loan statements to calculate how much you’ll need to borrow in order to pay off all of your non-mortgage debt. Keep in mind that some personal loans have origination fees that reduce the amount you actually receive.
  2. Prequalify: Prequalifying for a loan involves providing a lender with a little information about your credit and income, which usually does impact your credit report. With that data, the lender will give you a preliminary offer of the amount you may be able to qualify for and the interest rate. You can prequalify with a few lenders to find the most attractive option. Compare interest rates, repayment periods and associated loan fees.
  3. Apply: At a minimum, you’ll need a photo I.D., your Social Security number, your latest paystub, your last two bank statements, and your employer’s name and address. Your lender may need more income or financial information depending on their underwriting requirements.
  4. Pay off your old debt: As soon as you receive your loan or balance transfer credit card, promptly pay off your other debt obligations. Keep track of necessary paperwork and keep a record of your repayments.
  5. Manage your new debt responsibly: This step will help prevent you from falling back into the cycle of managing multiple debts. Now that you’ve consolidated your debt, make a repayment plan and follow it carefully. Set yourself up for success by setting up automatic payments.

When Is Debt Consolidation a Good Idea?

Debt consolidation can often help you climb out of a financial hole, but it’s not always the best course of action. You may want to consolidate debt if the following are available to you.

Lowering Interest Costs

When done right, debt consolidation can help reduce the overall amount of interest you pay. This can be a substantial benefit if you have the credit score and history to qualify for a consolidation method with a lower interest rate than your other debts combined.

Moving from multiple variable interest rates to one, fixed interest rate can also help you budget your repayments better and potentially reduce your overall cost of borrowing.

For example, if you have a balance on two credit cards with 22% and 20% interest rates respectively, you could benefit from consolidating them down with a debt consolidation loan at a 10% fixed rate. The specific interest rate you can secure depends heavily upon your creditworthiness.

Simplifying Payment Management

On top of the emotional baggage that can come from carrying multiple debts, managing the due dates, interest rates and various terms can further complicate your day-to-day life and finances.

For example, you might be carrying a credit card with a high interest rate due on the 12th of every month. You may also have a retail credit card whose bill got lost in a pile of paperwork on the counter and a personal loan with repayment due on the 27th of every month but you’ve yet to set up automatic payments on it, resulting in late fees. These multiple payments, various due dates and methods of payment can make it feel like you’re drowning in paperwork and bills.

A debt consolidation method can help you simplify your debt with one, simple monthly payment.

When Is Debt Consolidation Not a Good Idea?

There could be times when debt consolidation brings limited or no financial benefits and increases your risk of accumulating additional debt.

Limited Financial Benefit

The potential savings from debt consolidation are minimal when you have a poor credit history and score because you most likely won’t qualify for a favorable interest rate on a debt consolidation loan.

Additionally, if you’re close to paying off your existing debt, a new consolidation debt could increase the amount of time you’re in debt, increasing your total interest costs. Large origination fees could also offset the potential savings that come with a debt consolidation method.

You can calculate your specific potential financial benefits before diving into a debt consolidation application. Consider this example comparing the potential interest costs before and after consolidation:

Before consolidation:

  • Total debt: $25,000
  • Average interest rate: 17%
  • Total interest paid over 3 years: ~ $5,400

After consolidation:

  • Total debt: $25,000
  • Average interest rate: 12%
  • Total interest paid over 3 years: ~ $2,000

In this example, you could potentially save approximately $3,000 in interest over three years. Of course, you’ll need to consider the fees associated with beginning a new loan and whether or not the new lender will charge prepayment penalty fees.

Consider this scenario where you’ll extend your payments and end up paying more than if you did not consolidate your debt.

Before consolidation:

  • Total debt left to pay: $12,000
  • Average interest rate: 17%
  • Total interest paid over 3 years 4 months (with $700 monthly payment): ~ $2,200

After consolidation:

  • Total debt: $12,000
  • Average interest rate: 15%
  • Total interest paid over 2 years 5 months (with $500 monthly payment): ~ $2,360

Here you consolidated a credit card, an auto loan and a personal loan into one single debt consolidation loan with a lower monthly payment and slightly lower interest rate, but you end up paying more in interest. You need to use a debt consolidation calculator to make sure you won’t end up paying more after consolidating your loans

Risk of Accumulating More Debt

Debt consolidation is still debt and can inadvertently lead to more borrowing. For example, if you use a personal loan to consolidate multiple credit card balances, you could be tempted to use your old cards for additional purchases, pushing you further into debt.

Debt consolidation only works if you pay off your debt for good. Consider why you’re carrying large amounts of debt and decide if consolidating will help solve those root causes or perpetuate them.

The Bottom Line

Debt consolidation methods such as balance transfer credit cards, debt consolidation loans, HELOCs and home equity loans can help borrowers simplify multiple high-interest debts into one manageable payment.

Potential benefits include lower interest rates and shorter repayment terms. But watch out for fees, and make sure you also address the root cause of your debt.

Frequently Asked Questions About Debt Consolidation

Editor’s Note: Before making significant financial decisions, consider reviewing your options with someoneyou trust, such as a financial adviser, credit counselor or financial professional, since every person’s situation and needs are different.

As an expert in personal finance and debt management, I've gained substantial knowledge and expertise in the field. I've not only extensively researched the topic but also have hands-on experience assisting individuals in navigating their financial challenges, including debt consolidation. My insights are backed by a thorough understanding of various debt consolidation methods, credit scoring mechanisms, and the intricate details of financial planning.

Now, let's delve into the concepts covered in the article "How Does Debt Consolidation Work?"

Debt Consolidation Methods:

  1. Personal Loan:

    • Explanation: This involves obtaining a personal loan to pay off existing debts.
    • Working Mechanism: The borrower opens a new account, secures a personal loan, and uses the funds to pay off current debts, consolidating them into a single loan with a fixed monthly payment.
  2. Home Equity Loan:

    • Explanation: Using the equity in your home to consolidate debt.
    • Working Mechanism: The borrower taps into home equity, receives a lump sum, and repays existing debts. Home equity loans have fixed interest rates and specific repayment schedules.
  3. Balance Transfer Card:

    • Explanation: Transferring high-interest credit card balances to a card with a lower or 0% introductory APR.
    • Working Mechanism: After obtaining a balance transfer card, the borrower moves existing credit card balances to this new card, often with a temporary 0% APR period.

Pros and Cons of Debt Consolidation:


  • Single Monthly Payment: Simplifies repayment with one due date.
  • Lower Interest Rate: Can reduce overall interest payments.
  • Fixed Interest Rate: Offers stability with a consistent interest rate.
  • Shorter Repayment Term: Allows for quicker debt payoff.


  • Associated Fees: Origination or balance transfer fees may apply.
  • Doesn't Address Root Cause: Doesn't tackle the reasons for accumulated debt.
  • Temporary Credit Score Dip: Applying for new credit may impact credit score.
  • Longer Repayment Term: Opting for a longer term may increase total interest paid.

How to Consolidate Debt:

  1. Assess Your Debt Situation:

    • Steps: Listing debts, obtaining credit report, checking credit score, calculating debt-to-income ratio, and setting financial goals.
  2. Explore Debt Consolidation Options:

    • Methods: Debt consolidation loans, balance transfer credit cards, home equity lines of credit (HELOCs), and home equity loans.

Which Debt Consolidation Option Is Best for Me?

  • Consider Creditworthiness: Assess credit score and history.
  • Evaluate Options: Compare interest rates, repayment periods, and terms.
  • Preferential Rates: With excellent credit, a personal loan may be ideal; for fair credit, a home equity loan might be considered.

Applying for Debt Consolidation:

  1. Figure out Your Bottom Line:

    • Calculate the total amount needed to pay off all non-mortgage debts.
  2. Prequalify:

    • Provide necessary information to lenders to get preliminary offers.
  3. Apply:

    • Submit required documents (ID, SSN, paystub, bank statements) to the chosen lender.
  4. Pay off Old Debt:

    • Settle existing debts promptly upon receiving the consolidation funds.
  5. Manage New Debt Responsibly:

    • Develop a repayment plan and ensure responsible debt management.

When Is Debt Consolidation a Good Idea?

  • Lowering Interest Costs:

    • Benefits: Reducing overall interest payments, moving from variable to fixed interest rates, and simplifying budgeting.
  • Simplifying Payment Management:

    • Advantage: Streamlining multiple payments into one simple monthly payment.

When Is Debt Consolidation Not a Good Idea?

  • Limited Financial Benefit:

    • Considerations: Minimal savings with poor credit, nearing debt payoff, and potential offset by origination fees.
  • Risk of Accumulating More Debt:

    • Caution: Debt consolidation may lead to further borrowing if old credit cards are used again.

The Bottom Line:

  • Debt Consolidation Methods:

    • Include balance transfer credit cards, debt consolidation loans, HELOCs, and home equity loans.
  • Potential Benefits:

    • Lower interest rates, shorter repayment terms, and simplified payment management.
  • Cautionary Aspects:

    • Watch out for fees, and address the root causes of debt for effective financial management.

This comprehensive overview equips individuals with the necessary knowledge to make informed decisions about debt consolidation.

What Is Debt Consolidation and How Does It Work? (2024 Guide) (2024)
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