Debt Consolidation

Debt consolidation is an effective solution for consumers overwhelmed by credit card debt. It can be done with or without a loan. Consolidation should reduce the interest rate on debt, thus reducing the monthly payment..

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Benefits of Debt Consolidation

One Monthly Payment

The average credit card user owns four cards, meaning four payment dates a month. Consolidation simplifies that by reducing it to one payment a month.

Lower Interest Rate

The primary goal of debt consolidation is to lower your interest rate. This saves money and helps create a more affordable monthly debt payment.

Faster Payoff

Consolidation can lower interest rates to 8% and cut 6-8 months off your payoff time. Apply all savings to the debt, and you’ll pay it off even faster.

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What Is Debt Consolidation?

Debt consolidation is a sensible financial strategy for consumers tackling credit card debt. Consolidation merges multiple bills into a single debt that is paid off monthly through a debt management plan or consolidation loan.

Debt consolidation reduces the interest rate on your debt and lowers monthly payments. This debt-relief option untangles the mess consumers face every month trying to keep up with multiple bills and multiple deadlines from multiple card companies.

In its place is a simple remedy: one payment to one source, once a month.

Debt Consolidation Requirements

Any form of consolidation requires you to make monthly payments, which means that you must have a steady source of income.

If you are looking at a debt consolidation loan, the second requirement is that you be creditworthy. Lenders regard your credit score as the most obvious sign of your creditworthiness. If your score is above 740, you’re definitely good to go. If it’s between 670-739, you probably qualify, but may pay a higher interest rate. It’s possible you qualify with a score below 670, but what you likely will get is a bad credit consolidation loan, with an interest rate so high, it may not be a worthwhile option.

If you choose debt management as your consolidation program, there is no loan involved and credit score is not a factor.

Stacked Credit Cards

How to Consolidate Debt

Debt consolidation works when it reduces the interest rate and lowers the monthly payment to an affordable rate on unsecured debt such as credit cards. There are a few steps you need to take to make that happen.

Add Up Debt

1. Add up Your Debt

The first step in consolidating your debt is to figure out how much you owe. This will help you determine how much to borrow – if you choose to consolidate with a loan.

Calculate Debt

2. Calculate Your Average Interest Rate

Each credit card will have a different interest rate with a different balance, so the number you really are looking for is the weighted average interest rate. Find an online calculator and let it do the math for you. Your average credit card interest rate will give the lender a number to beat.

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3. Determine an Affordable Monthly Payment

Next, look at your monthly budget and spending on necessities like food, housing, utilities and transportation. After paying those bills, is there money left that can be used to pay off credit cards? Your monthly consolidation payment must fit your budget.

Weigh Consolidation Options

4. Weigh Your Consolidation Options

This will require a little research as there are a few options to choose from:

Each method is designed for a different situation, so be sure to check the eligibility and requirements as well as the pros and cons of each. There is a cost to each type of consolidation such as interest (loans), monthly fees (debt management) or taxes and fees (debt settlement).

Chalk Pie Chart

Types of Debt Consolidation

There are several avenues open to consolidate debt, including a debt management plan; home equity loan; personal loan; credit card balance transfer; and borrowing from a savings/retirement account.

The route you choose should be based on research and whether the solution offered fits your budget and time frame. Your credit score and debt-to-income ratio are factors, if you choose to get any kind of consolidation loan. You many also choose to pursue online debt consolidation.

Here is a quick look at each option.

Debt Management Plan

The goal of a debt management plan is to reduce the interest rate you pay, lower the monthly payments and eliminate debt in 3-5 years. These plans are offered by nonprofit credit counseling agencies, who receive concessions on interest rates from credit card companies to arrive at an affordable monthly payment for the consumer. You send that monthly payment to the counseling agency, which then distributes it to the credit card companies in agreed upon amounts until the debt is eliminated.

Personal Loan

This is a form of consolidation loan that could come from a bank, credit union, peer-to-peer lender or maybe even a family member or friend. Personal loans usually are unsecured, meaning the borrower doesn’t put up any collateral. That could result in a higher interest rate and less money available for the loan. A good credit score will help lower the interest rate. The best rates likely will come if you can find a friend or relative to offer you a personal loan. Generally speaking, those come with better terms and conditions that make this a good option, so long as you repay it on time.

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Credit Card Balance Transfer

Most credit card companies offer a balance transfer card that is very attractive, but may not be available to you, based on your credit score. These cards allow you to transfer the balance from your cards to a new card and make payments at 0% interest for an introductory period (usually 12-18 months). There usually is a transfer fee of 3%-5% of the balance transferred. That fee is added to your balance. You also must qualify for these cards with a healthy credit score, usually above 670. Also, if you have not paid off the balance by the time the introductory period ends, you will be charged standard interest rates.

Home Equity Loan

If you have equity in your house – meaning you owe less than the house’s market value – you could use home equity for debt consolidation. Typically, banks allow you to borrow against 80% of the equity you have. So, if you have $50,000 in equity, you could borrow $40,000 to pay off credit cards. You should pay considerably less interest than what you pay on your unsecured credit cards because you are offering your home as collateral. However, that puts you in danger of losing the house to foreclosure if you miss payments on the home equity loan or home equity line of credit (HELOC).

Retirement/Savings Accounts

If you have a job that provides a 401k account – and you’re just plain tired of dealing with credit card debt – you can take out a loan against your 401k retirement plan or dip into your savings account to pay off the debt. The good news is that with a 401k loan, you are borrowing your own money so there is no credit check and rates are low. The bad news is you are taking money from your retirement nest egg and will be penalized if you withdraw the money before the age of 59 and a half. There also are taxes on this. So, while it seems like a good idea, think hard before going after money in a 401k or savings account to pay off credit cards.

Do I Need a Loan to Consolidate My Debt?

You do not need to take out a loan when consolidating credit card debt. A debt management program eliminates debt in 3-to-5 years, without the obligation to enter into a loan agreement.

Credit counseling agencies that offer nonprofit debt consolidation have working agreements with credit card companies to reduce the interest rate on your debt to somewhere near 8% (sometimes less) and arrive at an affordable monthly payment.

Consumers make the fixed monthly payment to the agency, which distributes the money to the card companies in agreed upon amounts.

If you miss a payment or leave the program early, the only penalty is to revoke whatever concessions were made on your interest rate.

Should I Consolidate My Debt?

There are several markers that tell you when debt consolidation is a good idea. Those markers include:

  • When you have a steady income that exceeds your monthly expenses
  • When you can lower the interest rate on your deb, preferably to 8% or less
  • When you qualify for a 0% interest rate credit card
  • When the monthly payment is an affordable part of your household budget
  • When those payments actually reduce the balance owed each month, rather than just meeting the minimum amount required
  • When you can pay off your chosen route – debt management plan or consolidation loan – in less than five years

If you want to be responsible with your money and step away from credit card dependence, you need a plan. Debt consolidation is a plan.

Calculate If Debt Consolidation Is Right for You

When Is Debt Consolidation Not a Good Option?

Debt consolidation is not going to work for everyone for the simple reason that habits and motivations differ in every household.

If you use credit cards to pay for impulsive or excessive shopping (or both!), consolidation is not a good option.

If you got into trouble because you don’t have a budget – or won’t stick to the one you do have – or aren’t disciplined enough to make on time payments, then debt consolidation won’t work. The same problems that got you into trouble, will continue.

From a practical standpoint, if you can pay off your debts in 12-18 months (or less), consolidation isn’t necessary. Just do it! The fees and time associated with enrolling in a debt management program or getting a loan won’t be worth it.

Your best bet is to seek the free advice of a nonprofit credit counselor. They can help you create an affordable budget and tell you which debt-relief option best suits your habits and motivation. And the advice is FREE!

Debt Consolidation Alternatives

While debt consolidation is a suitable solution for most consumers, it doesn’t suit everyone. Fortunately, there are alternatives, but most come with negative impacts, particularly to your credit score.

Here is a look at some alternatives to debt consolidation:

Debt Settlement

If you reach the desperation point with credit card debt, one of two forms of debt settlement might be the solution to your problem.

With traditional debt settlement, you (or a company you hire), negotiate with the card company or the debt collection agency that owns your account to pay less than you owe, sometimes as much as 50% less.

A new version of that, called “Nonprofit Debt Settlement,” or “Credit Card Forgiveness”, tosses out the negotiating part of the deal. A small group of nonprofit credit counseling agencies have an agreement upfront with card companies, who agree to accept 50%-60% of what is owed to settle the debts.

Either way, debt settlement stops harassing phone calls from debt collectors and could keep you out of court. That sounds great, but it’s not easy.

With traditional debt settlement, you need to create an escrow account and pay into it regularly so you can make a lump-sum payment to settle the debt. That could be difficult. There is also the matter of fees (if you hire a company), taxes (on amount forgiven) and severe damage to your credit score for seven years.

With nonprofit debt settlement, not all card companies will agree to accept less than what is owed and not all nonprofit credit counseling agencies provide this option. The program is 36 months of payments and can’t be extended. You must call a nonprofit credit counseling agency to see if they are participating.

Still, paying less than what you owe is an attractive option, even if there are numerous downsides that go along with it.

» Learn more: Debt Settlement vs. Debt Consolidation

Create a Budget

Survey numbers vary wildly on this topic, but it’s generally accepted that around 60% of Americans don’t use a budget.

That might be why 66.3% of U.S. consumers don’t pay off their credit card debt at the end of every month. They don’t know how much money they spent, they just know it was more than they brought home.

They need a budget. And so do you. Pencil and paper still work, but there are a dozen phone apps that will do everything for you.

Create an affordable monthly budget and include a line for paying off debt. If you manage the budget carefully – and income actually exceeds expenses – you have money left over to eliminate credit card debt.

What’s the best method for using that “left over” money? Two methods worth considering are the “Debt Avalanche” and “Debt Snowball” approaches.

With the debt avalanche, you focus on the credit card with the highest interest rate and pay as much as you afford on it every month, while still paying the minimum amount due on any other cards. When that one is paid off, go after the next card with the highest rate and repeat the process. This method will save you the most money because you’re eliminating the highest interest cards.

The debt snowball method is similar, but start with the card that has the lowest balance. Pay the minimum on every other card and use what money you have left to pay off this card. When it drops to zero, take the next card with the lowest balance and repeat the process.

Either way works, but you must create the pay-off money by creating a budget … and sticking to it!

Cash-Out Refinance

If you have lived in your home long enough, you may have built up enough equity to do a cash-out refinance and use the money to pay off high-interest credit card debt.

Cash-out refinance allows you to get cash for the equity you have, in exchange for taking out a new mortgage. Here is what it looks like in math terms.

Let’s start with you taking out a $250,000 loan to buy your home. Over time, you have paid down that loan to $200,000, which leaves you $50,000 in equity.

Let’s say you need $25,000 to settle all your credit card debts.

So, you take out a cash-out refinance loan for $225,000. You use the first $200,000 to pay off what’s left of your first mortgage and use the other $25,000 to pay off credit card debt.

Now, you have a mortgage of $225,000, but you have eliminated the credit card debt.

However, there are some concerns to consider before trying this.

  • You must have a sizeable amount of equity. Lenders usually only fund 80% of the equity in your home.
  • There are fees associated with the process, including an appraisal.
  • The interest rate you pay may be higher (or lower) than what you currently pay.
  • You are putting your home at risk if you can’t make payments on the new loan.


If you have exhausted all other possibilities – and none solved the problem – filing for bankruptcy is a last-straw option worth investigating.

If you qualify, filing Chapter 7 bankruptcy is a fast way out. A successful filing will eliminate all unsecured debts, including credit cards, and give you a second chance financially, but there are qualifying standards you must meet.

If you don’t qualify for Chapter 7, then Chapter 13 bankruptcy is an option. Chapter 13 is different in that you submit a plan to pay back lenders in 3-5 years. If you meet the provisions of that plan, other debts will be cancelled.

The reason bankruptcy isn’t the automatic choice for all consumers trying to shake credit card debt, is that there is a severe negative impact on your credit report 7-10 years that could keep you from obtaining any loans or credit.

How to Get Started

Don’t let credit card debt become a burden in your life. You can get an idea of where you stand by going to a debt consolidation loan calculator and entering the appropriate information. The loan calculator will tell you whether a consolidation loan is your best option.

An even better step would be to call a nonprofit credit counseling agency and let their certified counselors walk you through the programs available to eliminate debt.

Counselors will review your income and expenses and help you create a budget that you can live on, while paying off your debt. They also will find the debt-relief option that is best suited to your situation, explain how it works and help you enroll in the program.

Best of all, credit counseling is FREE! It won’t cost you a thing to find out how to regain control of your finances and remove the burden of debt from your life.

Debt Consolidation FAQs

Debt consolidation can be difficult for people on a limited income. There must be room in your monthly budget for a payment that at least trims the balance owed. Even with a limited income, however, there can be places where you reduce expenses -- don’t eat out; eliminate cable and other entertainment spending; no trips to clothing stores -- to make debt consolidation work. It may come down to how committed you are to eliminating debt.

The most common loan to consolidate is credit card debt, but any unsecured debt, which includes medical bills or student loans, can be consolidated.

Anyone with a good credit score could qualify for a debt consolidation loan. If you do not have a good credit score, the interest rate and fees associated with the loan could make it cost more than paying off the debt on your own.

Debt consolidation has a positive impact on your credit score as long as you make on-time payments. If you choose a debt management program, your credit score will go down for a short period of time because you are asked to stop using credit cards. However, if you make on-time payments in a DMP, your score will recover, and probably improve, in six months.

If you go with a debt consolidation loan, paying off all those debts with a new loan, should improve your score almost immediately. Again, making on-time payments on the loan will continue to improve your score over time.

The alternative DIY method is obvious: Get rid of your credit cards. Lock ‘em in a drawer and hide the key. Pay for everything in cash. Set aside a portion of your income every month to pay down balances one card at a time, until they are all paid off.

More About: How to Consolidate Debt Without Hurting Your Credit

The cost of debt consolidation depends on which method you choose, but each one of them includes either a one-time or monthly fee.  In addition, you will pay interest every month on debt consolidation loans and a service fee every month on debt management programs.  

Generally speaking, the fees are not overwhelming, but should be considered as part of the overall cost of consolidating debt.

Most lenders see debt consolidation as a way to pay off obligations. The alternative is bankruptcy, in which case the unsecured debts go unpaid and the secured debts (home or auto) have to be foreclosed or repossessed. Lenders don’t like either of those choices. You may see some negative impact early in a debt consolidation program, but if you make steady, on-time payments, your credit history, credit score and appeal to lenders will all increase over time.

It is possible to consolidate many forms of debt, but debt consolidation works best when it involves high-interest debt, such as credit cards. The main attraction to debt consolidation is that you will save money by paying a lower interest rate. Some debt, such as medical bills (usually 0% interest), car loans and mortgages already have a low or no interest rate, there is no advantage gained in consolidating them.

The best answer is a financial advisor you trust. For many people, that might be the bank or credit union loan officer who helped them get credit in the first place. If you don’t have a personal relationship with a lending institution, the best idea is to call a nonprofit credit counseling agency and speak with a certified counselor. The nonprofit status means counselors must provide answers that are in the customer’s best interests, not the company’s bottom line.

FAQ Illustration of Questions and Answers

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