The pros and cons of debt consolidation


If you have multiple sources of debt, like high interest credit cards, medical bills, or personal loans, debt consolidation can combine them into one fixed monthly payment.

Getting a debt consolidation loan or using a credit card with balance transfer can make sense if it lowers your annual percentage rate. But debt refinancing has pros and cons, even at a lower rate.

Benefits of debt consolidation

You might receive a lower rate

The biggest benefit of debt consolidation is to pay off your debt at a lower interest rate, which saves money and could eliminate debt faster.

For example, if you have a total debt of $ 9,000 with a combined APR of 25% and a combined monthly payment of $ 500, you will pay $ 2,500 in interest over about two years.

But if you were to take out a debt consolidation loan with an APR of 17% and a two-year repayment term, the new monthly payment would be $ 445 and you would save $ 820 in interest. The money you save on the lower monthly payment could also be used to pay off the loan sooner.

If you qualify for a balance transfer card, you will not pay any interest during the promotional period, which can last up to 18 months. You will likely also have to pay a balance transfer fee of 3% to 5%.

Use a debt consolidation calculator to see your total balance, your total monthly payment, and the combined interest rate of all your debts.

You will only have one monthly payment

Instead of tracking multiple monthly payments and interest rates, consolidation allows you to combine the debt into one payment with a fixed interest rate that won’t change during the life of the loan (or during the promotional period, in the case of a transfer card balance).

But it’s not just about simplifying your repayments. Consolidation can give you a clear, motivating finish line for debt relief, especially if you don’t have a debt repayment plan in place.

You could build your credit

Applying for a new form of credit requires a serious credit investigation, which can temporarily lower your score by a few points.

However, if you make your monthly payments on time and in full, the overall net effect should be positive, especially if you consolidate your credit card debt.

Paying off credit card balances lowers your credit usage rate, which is one of the main factors determining your score.

Disadvantages of Debt Consolidation

You cannot benefit from a low rate

Balance transfer cards can be difficult to obtain and generally require good to excellent credit (690 or higher on the FICO scale).

Debt consolidation loans are more accessible and there are loans suitable for bad credit applicants (629 or less on the FICO scale). But borrowers with the highest scores usually receive the lowest rates.

Unless the lender can offer you a lower rate than your current debt, debt consolidation is usually not a good idea. In this case, consider another debt repayment strategy, such as the debt avalanche or debt snowball methods.

Borrowers looking to consolidate with a loan can pre-qualify with certain lenders to see potential rates without affecting their credit scores.

You could fall behind on payments

If you don’t pay off the new debt, you might find yourself in a worse situation than you started with.

For example, if you don’t pay off your balance transfer card during the promotional interest-free period, you’ll be forced to pay it off at a higher APR – potentially higher than the original debt.

If you fall behind on a consolidation loan, you could accumulate late fees and missed payments would be reported to the credit bureaus, jeopardizing your credit rating.

Before consolidating, make sure the new monthly payment fits comfortably into your budget for the entire repayment period.

You did not solve the problem at the root

While consolidation is a useful tool, it is not a safe solution for recurring debt and does not address the behaviors that led to the debt in the first place.

If you are struggling with overspending, consolidation could be a risky choice. By taking out a loan to pay off credit cards, for example, those cards will again have a zero balance. You might be tempted to use them before the new debt is paid off, plunging you into an even deeper hole.

If you have too much debt, you might be better off seeing a credit counselor from a reputable nonprofit that can help you put a debt management plan in place, rather than trying to adjust it yourself.

More from NerdWallet

Jackie Veling writes for NerdWallet. Email: [email protected]

The Pros and Cons of Debt Consolidation article originally appeared on NerdWallet.

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