The Pros and Cons of Debt Consolidation

Debt consolidation is not a one-size-fits-all solution. We can explain the pros and cons of debt consolidation in this article, but if you are still not sure if debt consolidation is a good idea for you, consider getting professional debt help.

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When your resources are stretched thin, paying the bills can feel like a game of financial Whac-A-Mole. The due dates seem to come at you from everywhere and all at once. Credit card bills on top of car payments on top of doctor bills with another credit card bill under that and that dang student loan payment!

Is there an easier way to take care of all of this?

Debt consolidation could be the solution you need. It can reduce your payments to a single monthly charge that is less than the sum of the multiple monthly debts you consolidate, and it should come with a lower interest rate than you’re paying on the credit card debt you’ve amassed trying to smack down those other bills.

It sounds good, and in many cases it is. But debt consolidation isn’t always the wisest way to get out from under the weight of the money you owe. It has advantages, yes, but there can be drawbacks, too.

For debt consolidation to work for you, it has to fit your financial situation. We’ll outline some of the debt consolidation pros and cons here with the caveat that you don’t have to take our word for them. We encourage you to consult with a nonprofit credit counselor before you take the debt consolidation plunge.

What Is Debt Consolidation?

Debt consolidation is the process of converting a number of debts into one balance, and it reduces your payments to one a month for a fixed amount. When it’s the right solution for you, you should be paying a lower interest rate on the new balance than you did when you paid your monthly obligations individually.

There are three kinds of unsecured debt you can consolidate: credit card debt, student loans, and high-interest personal loans. That means debt consolidation won’t directly help you with your mortgage, but by streamlining your other debts and reducing your monthly payments, it can free up some resources to put toward the balance you still owe on the house.

One way to consolidate your debts is with a new loan, typically from a bank, credit union or online lender. If you’ve been running up charges on multiple credit cards, you can use the money from a debt consolidation loan to reduce the balance to zero on all of those different cards.

You still owe the same amount you did before you took the loan, but now you’re only making one monthly payment to the new lender rather than one payment to Visa, another to MasterCard, a third to American Express and a fourth to Discover. That single fixed monthly payment should be lower than the sum of the others and it should come at a reduced interest rate, especially if you put up collateral such as your home or your car to back the loan.

A balance transfer credit card is another way debt consolidation can work, but only if you qualify. You can move the balances from all or some of your credit cards to the new transfer card, which usually offers a 0% introductory APR (annual percentage rate) for a brief period of time.

In essence, you’re using the new credit card to pay off your old cards. So, again, the amount you owe won’t change. But this debt relief option generally gives you 12-18 months to pay off your total credit card debt at the 0% introductory rate. That can be a money-saver.

However, it must be pointed out that you must have a good credit score (above 670) to qualify for a balance transfer card and there typically is a 3%-5% balance transfer fee added to your balance.

When Is Debt Consolidation a Good Idea?

This is where your unique financial situation comes into play. The goal is to match what you need or want from debt consolidation to the terms of an available loan or transfer card in a way that saves you money.

Generally, debt consolidation is a good idea when:

  • Your credit score is already in decent shape: If it’s around 670 or higher, chances are you’ll qualify for a lower interest rate than you’ve been paying on your current debts.
  • You’re saddled with a number of highinterest loans: You likely can knock down the rate you’re paying if you qualify for a debt consolidation loan, and a 0% APR on a transfer balance card will give you some time to pay off your credit card debt at no interest.
  • You’re confident you’ll be able to repay the new debt consolidation loan or the new balance on a transfer card: Once you commit, the ramifications of defaulting aren’t pretty.
  • You’re having trouble keeping track of multiple due dates on your debts: If that’s the case, the single monthly payment that comes with debt consolidation should be a relief.
  • You need the budgeting consistency of a fixed monthly payment: When you know how much you’ll be paying every month, it’s easier to see what you’ll have left to spend.

If you’ve had difficulty with previous debts (missing payments, defaulting, etc.) and your credit score has suffered as a result, you might not qualify for an interest rate low enough to make a debt consolidation loan or a balance transfer credit card work for you. That’s when it isn’t such a good idea.

Pros of Debt Consolidation

For a lot of reasons, debt consolidation can make great sense when you can’t quite see over the stack of bills piled up on your desk. If times get tough, the advantages of debt consolidation that fit your situation are well worth exploring.

Simplify Your Finances

Out of many, one. Instead of keeping tabs on how much you owe this creditor as opposed to that creditor as well as all those other creditors every month, you’ll only owe one lender. And you’ll only have one due date per month for the payment you make. If nothing else, that should slow down your head’s spin rate.

One Monthly Fixed Payment

If you’re like most of us, you carry credit cards with revolving debt. That means the amount you owe on those cards is different every month, which in turn means you don’t know from one month to the next how much you’ll have to pay. Debt consolidation gives you a payment that doesn’t change from due date to due date. You can count on it. As we mentioned earlier, that makes budgeting a lot easier.

Lower Interest Rates

You want to save money, right? You don’t need a lot of math skills to figure out that low-interest debt consolidation is going to be easier on your bank account than five debts at higher rates. For example, you could be paying a 25% interest rate to your credit card companies. Depending on your credit score and other factors, you could get a debt consolidation loan for as low as 6%.

Improve Your Credit Score

This one is up to you, but successfully consolidating your debt can give you a way to bump up your score. How? You’ve got to make that single monthly fixed payment on time, month after month. The longer you do that, the more you will improve your credit score, especially if you were struggling to keep up with multiple bills and due dates before you started the process. The credit rating agencies reward on-time payments.

Get Out of Debt Faster

This is a way to make effective use of the lower monthly payment and interest rate you get with a good debt consolidation plan. If you can afford to do it, you can apply some of the money you save to your single monthly payment, thus reducing the remaining balance more quickly. If, for example, your pre-consolidation payments totaled $600 but the lower rate on your debt consolidation loan or balance transfer card reduced that number to $500, you’ve got an extra C-note at your disposal. Add some of that to the new monthly $500 bill whenever you can, and you’ll cut down the length of the repayment term.

Cons of Debt Consolidation

Debt consolidation isn’t for everyone. It can be risky, and its success depends on some financial discipline on your part. Taking on a debt consolidation loan is a big decision. Before you sign the papers, make sure you’ve discussed the disadvantages of debt consolidation with a credit counselor. Be sure it fits in the budget you should be working from.

Debt Consolidation Won’t Solve All the Financial Problems

Debt consolidation can bring your credit cards down to a zero balance, which is great. But if you don’t keep those balances near zero, then it might not be the best debt relief option available to you. Debt consolidation can backfire on you when you can’t stop over-using your credit cards. You’ll need to change some of the bad habits that put you into your over-extended situation in the first place.

Up-Front Costs

Debt consolidation can come with strings attached, meaning you might run into expenses you hadn’t anticipated: loan origination fees, annual fees, closing costs, balance transfer fees and the like. They can cut into the savings you expected when you decided to make the move. Word to the wise: Shop around before you choose a debt consolidation loan.

You Might Pay More in Interest

The goal is to find a way to reduce the interest you’ve been paying. But if you aren’t careful, you could wind up taking on a debt consolidation loan that costs you more in interest in the end. Your credit score might not be strong enough to qualify for an interest rate that will make a difference in your debt total. Or you might agree to a longer-term loan that includes a lower monthly payment but costs you more in interest by the time you pay it off.

Missed and Late Payments Will Set You Back Further

Lenders don’t waste a lot of time in assessing late-payment fees. Miss one, and you’ll find out how quickly they’ll nick you. That applies to payments returned due to insufficient funds, too. If you’ve used a balance transfer card and don’t pay off the balance during the 0% introductory APR period (12 to 18 months), your interest rate will skyrocket. Remember, you’re trying to reduce your debts here, not take on unnecessary additional expenses. And by the way, missed and late payments generally get reported to the credit bureaus within a month, which will hurt your credit score going forward.

How to Get a Debt Consolidation Loan

Once you’ve decided a debt consolidation loan looks like a promising way to get your head back above water, it’s time to start your homework. Why? Because not every debt consolidation loan is the same. You’ll want to be sure you’re taking on the right loan with the right terms.

Remember, debt consolidation loans can come from three kinds of lenders: credit unions, banks, and online lenders.

Here’s a step-by-step primer for how to make the process work for you:

  • Get familiar with the status of your credit: If you don’t already know what it is, look into your credit score and make sure your credit reports are up to date and accurate. This is important because the loans you’ll investigate will have credit score requirements. A low score won’t necessarily be a deal-killer, though. Debt consolidation with bad credit is more challenging, but it can be done.
  • Know how much you need: Take stock of the balances on the debts you’re carrying and add the minimum monthly payments together. If you can, factor in how much a lender might take out of the loan amount in origination fees. All of that will help you figure out what amount of a fixed single monthly payment on a debt consolidation loan will work for you.
  • Investigate a number of different lenders: Check their websites for the terms they offer, the fees they charge, and the credit score eligibility they require. You might think local, too, if you already have an account with a credit union or a bank.
  • Prequalify: This should speed up the process for you. When you’re pre-qualified, lenders can zero in more quickly on what terms and loan rates might be available for you.
  • Fill out a formal application: Depending on the lender you choose, it can be done online, in person or sometimes even over the phone.

Once your application is approved, the lender should transfer the loan funds to you in short order. As soon as you have the money, it’s up to you to pay off the individual debts you’re consolidating with the loan.

Speak With a Credit Counselor About Debt Consolidation

Debt consolidation is complicated. Everyone’s financial situation is different. A balance transfer credit card will work for some people but not others. A debt consolidation loan has to come with the right terms and for the right amount if it’s going to bring you the relief you need.

The smartest way to work through the intricacies is with credit counseling from a nonprofit credit counseling agency certified by the National Foundation for Credit Counseling (NFCC). A credit counselor will discuss your unique financial situation, examine the debts you might want to consolidate, review your credit report with you, and help you understand your best loan consolidation options.

Though it can be offered in person or online, a counseling session typically is done over the phone and usually lasts about 40-45 minutes. And there is no charge for the service.

About The Author

Michael Knisley

Michael Knisley was an assistant professor on the faculty at the prestigious University of Missouri School of Journalism and has more than 40 years of experience editing and writing about business, sports and the spectrum of issues affecting consumers and fans. During his career, Michael has won awards from the New York Press Club, the Online News Association, the Military Reporters and Editors Association, the Associated Press Sports Editors and the Sports Emmys.


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