What Is Debt Consolidation and How Does It Work? 3 Ways to Do It Right

Payday is supposed to be a happy day. It’s supposed to serve as a pat on your back for all the hard work you’ve put in to earn that check.

But for people who have debt piling up to the sky, payday is anything but happy. It’s not easy looking at your paycheck knowing that only some of it belongs to you.

From the moment you receive your paycheck, it’s only a matter of time before a huge chunk of it disappears because of debt payments. Or maybe debt collectors are already calling and you’re on the brink of bankruptcy.

Either way, you need relief fast.

Debt consolidation could be the answer you’re looking for. Let’s find out.

How debt consolidation works

When you consolidate your debt, you are combining all of your existing debt into one single loan. Your old loans are marked as paid off and the balances are combined into the new loan. Having one loan means having only one payment.

Consolidating your debt will give you a lower interest rate, which, in turn, will reduce your monthly payment amount. With a lower amount and only one loan to pay off, it’s easier to make consistent, on-time payments each month.

The goal is to save money and pay off your debt faster by taking advantage of a loan with a lower interest rate.

To illustrate, assume you have the following outstanding debts:

  • Credit card 1:$5,000 balance, a 23.49% APR, and a $150 minimum payment
  • Credit card 2:$7,5000 balance, a 21.49% APR, and a $200 minimum payment

The charts below compare the interest payments and time it will take to pay off both cards by only make the minimum payment to using a debt consolidation loan. Notice how much you can save in interest payments if you get a $12,00 fixed rate loan to consolidate the debt.

Should you consolidate your debt?

It depends on your circumstances and level of self-discipline. “If the root cause of the debtor’s debts arose from a one-time event which is not likely to recur, [it may be worthwhile],” notes consumer rights lawyer Donald E. Petersen.

But it may not be an effective way to deal with overwhelming debt if you’re not disciplined with your spending or continue robbing Peter to pay Paul, Petersen adds.

Calculate your level of debt and determine how long it will take you to pay it off. If you can pay off your debt within three to five years with a debt consolidation, it could be a great choice for you.

It can also be a good idea if your unsecured debt is less than half of your gross income.

Your credit score matters

Your credit score also plays a significant role in debt consolidation. The goal of consolidating your debt is to get a lower interest rate and monthly payment– it could save you thousands of dollars.

But you need to have good credit to get an interest rate that will allow you to reap the benefits of debt consolidation.

Credit-Building ToolMethodPrice 
Secured Credit Card$35 annual fee (plus security deposit)Apply
Secured Credit Card$29 annual feeApply

If you can’t get a lower rate by consolidating your debt, it may not make sense for you to go this route. And the chances of being offered a good interest rate with bad credit aren’t high. But it’s not impossible.

If you can wait to consolidate your debt until you’ve improved your credit score, great. You’ll have more success being offered a loan with a good interest rate.

But if you don’t want to take the time to rebuild your credit, there are other consolidation options you can consider.

What method should you use to consolidate your debt?

Debt consolidation is typically achieved using credit cards, home equity lines of credit (HELOC), or personal loans. Debt consolidation loans can be either unsecured or secured. The latter requires some form of collateral.

1) Personal loan

You don’t need stellar credit to qualify for a personal loan, but the most competitive loan offers are reserved for borrowers with excellent credit. Lenders look at your credit score to assess risk and help determine what interest rate to offer.

Pros

  • Lower interest rate with good credit
  • Lower payment
  • Convenience of paying one lender each month
  • No collateral required
  • Easy application process and fast approval
  • If approved, funds will be transferred to your account within a few days
Cons

  • Loan origination and administration fees may apply
  • Must have good credit to qualify for a good interest rate
  • Secured loans put your assets at risk for repossession
  • Longer loan terms could cost you more in interest

Before applying for a personal loan, be sure to compare rates and terms offered by various lenders.

To get started, use SuperMoney’s loan offer engine to request personalized rates and narrow down your best options (this will not affect your credit score).

Featured lenders for personal loans

Lending PartnerMinimum FICO scoreEstimated APR 
60015.49% – 34.99%*Apply
6802.19% – 17.49% (with AutoPay)*Apply
650Fixed:
5.49% – 14.24% APR (with AutoPay)*
Variable:
4.99% – 11.14% APR (with AutoPay)*
Apply
6605.99% – 35.89%*Apply
6204.93% – 29.99%*Apply
5809.95% – 35.99%*Apply
7005.25% – 12%*Apply

Then, head over to our personal loans reviews page to compare the rates and terms from those lenders, as well as other top lenders.

2) Balance transfer credit card

If you have good credit, you may want to explore balance transfer credit cards.

Upon approval, you can transfer your outstanding balances to the new card and enjoy a 0% promotional APR, ranging from 12 to 24 months, depending on the card.

Pros

  • You can transfer your balance to a credit card with better terms and close your old account
  • You can qualify for a promotional interest rate if you have excellent credit– it can be as low as 0% APR for six months or more
  • No collateral required
  • Easy application process and rapid approval
Cons

  • Hard to qualify for if you have less-than-perfect credit
  • High balance transfer fees (for each balance transferred)
  • Higher interest rate if you don’t qualify for a promotional interest rate
  • Credit could be hurt with a balance transfer (but can be recovered with consistent on-time payments)
  • Risk of incurring more debt if not disciplined with your spending

3) HELOC

Do you have equity in your home? A home equity line of credit may be a feasible option to take care of the overwhelming debt. But make sure you know the rates, terms, and closing costs of various lenders before committing.

Pros

  • Low-cost consolidation loan
  • Low interest rates
  • You don’t need great credit to qualify
  • Interest you pay is tax deductible
Cons

  • Secured loan using your home as collateral
  • Variable interest rate; could result in higher monthly payments over time
  • Hidden fees; potentially expensive origination, maintenance, and closing fees
  • If housing prices drop, lender can reduce or freeze your credit limit

Check out user reviews and ratings of the best online home loan lenders. 

Are you ready to consolidate your debt?

That may seem like a simple question to answer, but that isn’t the case for everyone. I know you’re ready to lower your interest rate and monthly payment– who isn’t? But that doesn’t mean you’re ready to consolidate your debt.

If debt consolidation isn’t done the right way, you won’t reap the benefits from it. In fact, it might make things worse for you. Don’t jump the gun too quickly. Do your research before committing.

Our personalized loan offer tool will help you make the right decision for your unique situation (without affecting your credit score). You’ll receive personalized offers from top lenders, putting you one step closer to finding the best solution to paying off your debt.

Featured lenders for personal loans

Lending PartnerMinimum FICO scoreEstimated APR 
60015.49% – 34.99%*Apply
6802.19% – 17.49% (with AutoPay)*Apply
650Fixed:
5.49% – 14.24% APR (with AutoPay)*
Variable:
4.99% – 11.14% APR (with AutoPay)*
Apply
6605.99% – 35.89%*Apply
6204.93% – 29.99%*Apply
5809.95% – 35.99%*Apply
7005.25% – 12%*Apply