Is Debt Consolidation a Good Idea?

If you have various high-interest debts — a student loan, a car loan, a couple of credit cards — debt consolidation can help you pay down debt faster.
 
It works like this: a lender, such as your bank or credit union, consolidates your debts into one larger loan. Your new loan usually has a lower interest rate. When you consolidate, you now make a single monthly payment, rather than paying multiple lenders and creditors each month.
 
You can consolidate all kinds of debt, such as auto loans, credit card debt, store credit card debt, student loans, personal loans, and medical debt.
 
Debt consolidation can be a great solution, but it isn’t for everyone. Read on to learn more so you can decide whether it’s the best choice for you.

Pros and cons of debt consolidation

Pros

There are several benefits to consolidating your debt:

• Money savings. When you consolidate high-interest debt into a low-interest loan, you’ll pay less interest over time. Debt consolidation loans usually come with a fixed interest rate, so that low rate is locked in.
• Quicker debt repayment. When you pay a lower interest rate, more of your monthly payment goes toward your principal, helping you pay off debt faster.
• Predictable repayment schedule. Most consolidation loans have a fixed repayment schedule, so you’ll know exactly when you’ll be debt-free.
• Fewer monthly payments. You make one loan payment each month, rather than paying multiple lenders and creditors.
• Improved credit score. Paying off old accounts and making on-time monthly payments toward your new loan can raise your credit score.
• No collateral required (in most cases). Most debt consolidation loans don’t require collateral to secure the loan. So if you default on the loan, you won’t lose an asset.

Cons

Before consolidating debt, it’s important to understand the potential downsides.

• Limited eligibility. Depending on your credit score, you may not qualify for a debt consolidation loan.
• A (tiny) drop in your credit score. Your lender will do a hard credit inquiry to determine whether you qualify for a debt consolidation loan. This may lower your credit rating, but usually ten points or less.
• Higher interest rate (in some cases). If your new loan has a higher interest rate than your existing loans, your overall debt cost will increase. The higher your credit score, the lower your interest rate will be.
• Fees. Some consolidation loans have high fees. Make sure you understand the details before taking out any loan.
• Temptation to rack up more debt. If you transfer your credit card balances to a new low-interest loan or credit card, your old credit cards will have zero balances again. If so, you may start making new purchases, causing your overall debt to rise.

When to consider consolidating your debt

Before leaping, get a handle on your unique situation.
 
First, check your credit score. A higher score will help you qualify for a lower interest rate on a loan. Some lenders offer debt consolidation loans to people with scores as low as 300, but those loans usually have sky-high interest rates. If your number is on the low side, take steps to improve your credit score before applying for a debt consolidation loan. If you have a healthy credit score and are carrying high-interest debts, debt consolidation may be a smart move.
 
Next, calculate your debt-to-income ratio (DTI). This involves listing your debts — including credit card balances, student loans, car loans, and such — as well as your income. If your DTI is under 50%, you may qualify for a debt consolidation loan. If it’s under 36%, you’ll likely qualify for a loan with a low interest rate.
 
You can then contact lenders to get loan quotes. Banks, credit unions, and online lenders all offer debt consolidation loans. Some prequalify you without doing a hard inquiry that might harm your credit score. When you take out a Patelco debt consolidation loan, you’ll receive support, including free financial counseling and a virtual financial mentor.
 
Finally, it’s time to do the math. Review your loan offers, including the interest rate and other terms, including any fees the lender may charge. If you qualify for better terms than you currently have and the monthly payment is reasonable, it might make sense to consolidate. If the offered interest rate is the same (or higher) than the loan or credit card rates you currently pay, or the lender charges high fees, consolidation may not be the right choice.

Gather your documents

Before applying for a debt consolidation loan, have your paperwork handy. Lenders generally ask to see pay stubs, bank statements, and tax documents.

What is the best way to consolidate debt?

The best way to consolidate debt depends on your financial situation and the types of debt you have.
 
Here are some options:

• Debt consolidation loan. A personal loan that you use to pay off various types of debt.
• Debt management plan. A credit counseling agency negotiates directly with your lenders and creditors to lower your interest rates, then consolidates your various loans so you can make a single monthly payment.
• Balance transfer credit card. You transfer balances from your high-interest credit cards to a new credit card that has a lower interest rate.
• Home equity line of credit (HELOC). You borrow against the equity you have in your home. A HELOC typically comes with a lower interest rate than other types of loans. If you default on the loan, however, you may lose your home.
• Student loan consolidation. If you have more than one federal student loan, you may be able to consolidate them into a single loan.