For those of us with that owe money to multiple sources, like more than one high-interest credit card, debt consolidation is a way to better organize your monthly bills – and potentially get a lower combined interest rate. It’s one method of dealing with too much debt, but it’s not the best path for everyone. It also comes with its own unique upsides and disadvantages.
If you are having difficulty managing your debt load, maybe consolidating is the right way to go, but there are also other options out there.
Who is debt consolidation best for?
People who don’t have self-control problems with their spending, have a decent credit score, their debt is less than half their income, and can manage to not run up more debt after they pay off all their high-interest credit cards.
Who should reconsider or avoid debt consolidation?
If you are a high-risk when it comes to racking up more debt after you first consolidate, if your debt is higher than 50% of your yearly income, if your debt is really small and can be paid off in about a year or less, or if you can’t qualify for a good debt consolidation loan due to poor credit history.
The basics: What is debt consolidation?
Debt consolidation is an easy concept: lumping up all your high-interest debt together in one place, typically for a lower interest rate. It’s simply getting a single loan that allows you to pay off all (or most) of your current debt load, so you can make just one monthly payment instead of juggling several monthly bills and various interest rates.
There are two main methods of debt consolidation.
The credit card way: It’s called a balance transfer card, and it’s simply the getting a 0% interest (for a specific period of time) credit card and transferring all your other card balances to the new card. If you can pay off your new bill during the introductory period (12-21 months), then you will end up paying zero interest – but you will still have to pay a small balance transfer fee (usually around 3%).
Discover it Balance Transfer Card: 0% APR for 18 moths, then 13.74% – 24.74% Variable APR
Amex EveryDay Card: 0% APR for 15 months, then 14.74% – 25.74% Variable APR
Citi Diamond Preferred Card: 0% APR for 21 months, then 14.74% – 24.74% Variable APR
The personal loan way: This is the more traditional route to take, and it simply involves getting a fixed-rate debt consolidation loan that you pay back in line with the agreed-upon terms. You get the lump sum, then pay off all your credit cards, etc. and then you just have to worry about one combined debt.
SoFi: Fixed and variable interest rates for $5,000 to $100,000 and no origination fees or minimum FICO score.
Upstart: Fixed interest rates for $1,000 to $50,000 and origination free of 1%-8%.
Citizens Bank: Fixed and variable interest rates for $5,000 to $50,000 and no origination fee.
Alternative options: You can also take two riskier routes, which are to take out a 401 (K) loan or a home equity loan, and they put either your retirement savings or your home on the line.
Figuring out if debt consolidation would help
It’s an incredibly tempting idea, the thought of only dealing with a single automatic monthly bill and not having nearly maxed-out credit cards for once. But for most people’s financial situations, debt consolidation probably isn’t the best way to go – and there are several reasons for that.
Which path you take towards simplifying your debt all comes down to your credit score and how much debt you have compared to your income.
What you need to do is simple: go online and use a free debt consolidation calculator. You can use one of these no-cost tools to enter all your different credit cards and it will tell you how long it will realistically take to pay off all that debt if you keep going at the same pace.
Then, compare those results with your quotes for personal loans you are considering, and also the introductory period of the balance transfer card you are considering and see which one makes more financial sense for you: consolidating or not consolidating.
But, hold on, there are other considerations to take as well.
When debt consolidation is your best option
This process is only the best decision for your financial life if you
- Have debt that
- Is less than half of your annual income
- Can’t be paid off in less than a year with your current pace of paying them down
- Have a decent credit score, so you can qualify for 0% interest balance transfer cards and personal loans.
- Don’t have self-control issues when it comes to spending. It’s very easy to consolidate your credit card debt and immediately rack up a bunch more debt right afterward. If you even think you may be tempted, debt consolidation isn’t for you.
If you know yourself well, and are confident that you can responsibly complete a debt consolidation plan, then you should certainly consider starting the process.
When debt consolidation might be wrong for you
The most important thing to remember is that a debt consolidation solution should achieve one or both of the following: simplifying your financial life without unreasonably increasing your debt, or lowering your monthly payments.
If they won’t achieve those things, then don’t do it. Otherwise, there are a ton of people out there who really shouldn’t try to consolidate their debt:
- If you have a problem keeping your spending under control: When you pay off all your credit cards, you will suddenly have a bunch of freed up cards with empty balances – meaning a lot of temptation to spend and run up more debt. A lot of us simply can’t control ourselves, and running up more debt while you’re servicing your debt consolidation loan will only dig you deeper into a hole. Either consolidate and cancel your paid-off cards (which may slightly negatively affect your credit score), or don’t consolidate at all.
- If you have a tiny amount of debt: If you can pay off what you owe in under a year going at your current payback pace, debt consolidation isn’t necessary – since you’d only be saving a very marginal amount, it’s not worth the energy and added credit history.
- If your debt is higher than 50% of your annual income: If you have a serious amount of debt that isn’t realistically possible to eliminate even with a much lower interest rate (more than half of what you earn), then you will be better off getting debt relief.
Debt relief is for those of us who are drowning in high-interest debts and a balance transfer card or personal loan isn’t an option, or wouldn’t help much. Debt relief methods include bankruptcy, debt management, and debt settlement.