What is debt consolidation?

Many people use debt consolidation to pay off credit card debt or other high-interest loans. And the average American credit card debt is $3,380, and around 24% of people said it would take longer than a year to pay off their credit card debt, according to Finder’s Consumer Confidence Index.

Whether you’re struggling to manage multiple debts each month, you want to pay off your debts faster, or you’re itching to save money on interest charges (or all of the above!) then consolidating may make sense for you.

How does debt consolidation work?

Debt consolidation works by moving multiple debts into one new account. You can consolidate your debt with personal loans or balance transfer credit cards.

One of the biggest advantages of debt consolidation is the savings opportunities. If you have a few loans with high interest rates, then consolidating them together with a lower interest rate can mean saving money over time. Additionally, having multiple debts together on one account can make money management easier.

Whether or not you save money can depend on the method you choose — such as a home equity loan or balance transfer card. If you go with a debt consolidation loan, you may get a blended rate that reflects the rates on the previously separate accounts.

What kind of debt can I consolidate?

Many people consider consolidating these kinds of debts:

How to consolidate debt in 5 steps

If you’re having trouble keeping up with multiple credit card and loan payments, consolidating your debt can help you lower your interest rate and handle your debts with a single monthly payment — but which option is best will depend on how quickly you can afford to pay off your debts.

Step 1: Collect the information you’ll need.

Week 1. Start by collecting the information and documents you need to calculate your expenses, including:

• Bills and expenses. Phone, utility, memberships, rent/mortgage and any other regular payments.
• Your bank statements. Download these online at most banks or visit a branch if you don’t have an online account.
• Any other important financial records. This includes bills, final notices and receipts for everyday purchases like groceries, restaurants and clothing.

Next, let’s exercise our bookkeeping skills:

1. Write down your expenses for the past month. Draw this out on paper or start a new spreadsheet to stay organized.
2. Add everything up. Get a ballpark figure for how much to budget for expenses each month. To be as accurate as possible, calculate your expenses for the last three months and find the average.
3. Calculate your income. If your expenses exceed your income, you need to re-evaluate. Consider the expendable costs you’re currently engaged in and think about the costs/luxuries you can do without.

Step 2: Check your credit score

Week 1. Once you know how much you owe and how much to budget, consider which debt consolidation solution offers you the most value. Before you make a decision, consider which options you’re eligible for.

A balance transfer credit card will require a higher credit score than a debt consolidation loan. If you don’t know your score, it’s easy to order a free copy of your credit file.

If you receive your credit file and find that your score isn’t up to scratch, you might want to improve your credit score before you apply for a new credit card or loan. Keep in mind that rejected applications can have a negative impact on your credit score, so rushing the process and applying for a solution you won’t be approved for could backfire.

Improve your credit score

Step 3: Compare, compare, compare

Week 2. If you’re considering consolidating your debt, there are a few key questions you should ask yourself to determine which option is right for you:

• When does the promotional offer end? If a balance transfer card comes with a 0% offer, it’s likely that it will only last for six to 24 months. Calculate whether you could repay your entire balance by the end of this period. If not, consider a debt consolidation loan or a card with a longer promotional period.

• How much can I transfer? Most balance transfer credit cards only accept balance transfers up to a fixed amount (or a percentage of your total debt).

• Who can I transfer from? Most providers won’t let you transfer balances from an existing account with the same bank. You might also find that you’re unable to transfer debts from partnered, affiliated or co-owned banks. Confirm which banks you can transfer between.

• Other fees and features. For balance transfer cards, details such as the annual fee, interest rates on purchases and rewards programs could also impact how you use the card during and after the balance transfer is in place.

• Eligibility requirements. Make sure you earn the minimum income requirement, have a good credit history and meet any other conditions before applying.

Step 4: Apply wisely

Week 2. Once you’ve compared your options and decided on one, it’s time to apply for your balance transfer card or debt consolidation loan. Choose the green Apply now button on the table to be directed to a secure online application with your preferred bank.

Most online applications will take approximately 10 to 15 minutes to complete and submit. To make sure the application process goes smoothly, ensure that you meet the eligibility requirements and have all of the required documentation on hand before beginning the application.

If you apply online, many providers can you give a response within 60 seconds or so based on the information you have provided. If you’re approved, you’ll receive confirmation and information packages regarding the card or loan and your account.

If there’s a problem or the provider needs to cross-check some information you’ve provided, your application status may be left pending. If you haven’t received any feedback for a few days, contact the provider directly to discuss the status of your application.

If you didn’t meet the eligibility requirements or failed to provide the necessary documents, you’ll receive a notification that your application has been rejected.

Remember that multiple rejected applications will have a negative impact on your credit score. If your application is denied, take the time to understand why, compare your options and wait a few weeks before applying again.

Consider debt relief if you don’t qualify for debt consolidation

Step 5: Start consolidating

Week 3. If your application for a balance transfer credit card has been approved, you can expect to receive your card within one to two weeks. If you applied for the balance transfer at the time of application, your balance should’ve transferred to your new account.

If your application for a debt consolidation loan has been approved, you’ll need to start paying off your creditors as soon as the money is deposited into your account.

If you haven’t already, spend some time mapping out a realistic budget and set of goals that’ll help you keep your monthly payments on track.

Use these three simple rules to keep yourself moving forward:

1. Set monthly goals.
2. Use calendar notifications to remind you when payments are due — or use a debt tracker app to stay on top of your bills.
3. Set a final date for when you’d like to have your debt repaid — preferably before the promotional period finishes if you’re using a balance transfer credit card

Pros and cons of debt consolidation

Consolidating debt can be helpful for some people, but it’s not a silver bullet. Consider these pros and cons:

6 best ways to consolidate your debt

Debt consolidation generally involves taking out a loan or credit card, but you have several types to choose from. The ideal option for you depends on how much you owe, your income and your credit score.

1. Debt consolidation loan

• Best for: Paying off large amounts of debt over several years at a low interest rate.

A debt consolidation loan is an unsecured personal loan you use to pay off one or more account balances. Typically, you can borrow up to $50,000 with APRs ranging from 5% to 36% that you pay back over three to seven years. Generally, you need good to excellent credit to qualify.

2. Balance transfer credit card

• Best for: Paying off credit cards over 21 months or less with no interest.

A balance transfer credit card allows you to move multiple credit card balances onto one new card. Often these come with 0% APR promotional rates that last up to 21 months.

But it’s not free. Often there’s also a balance transfer fee, which can range from 3% to 5% of the amount you transfer, usually with a minimum. You might also pay an annual fee. Generally, you need a credit score of at least 670 to qualify — what lenders consider to be good credit.

3. Secured personal loan

• Best for: Homeowners with large amounts of debt or mediocre credit.

A secured loan personal loan is one that you back with collateral. This can be anything of value that you own, like a savings account or CD. They’re typically easier to qualify for than other types of funding and can be a great option if your credit is less-than-perfect or you have a high debt-to-income (DTI) ratio.

4. Home equity loans and HELOCs

• Best for: Getting a more competitive rate with mediocre credit.

Also known as a second mortgage, a home equity loan or a home equity line of credit (HELOC) is backed by the amount you currently own in your home or by equity.

These typically come with lower rates than unsecured personal loans. But the risk is greater: You could lose your home if you default.

5. 401(k) loan

• Best for: Anyone with rock-solid job security and a 401(k) retirement account.

A 401(k) loan allows you to borrow from your retirement fund balance at a low interest rate — without paying early withdrawal fees.

You’re effectively paying interest to yourself, but you’re doing it with after-tax income — otherwise 401(k) contributions are before you pay taxes. You also stand to owe it all back in one lump sum if you leave your current employer — and you could be hit with penalties if you can’t pay it back immediately.

6. Student loan refinancing

• Best for: Anyone repaying student loans.

The best way to consolidate your private student loans is by combining them into one new loan with a student loan refinancing provider. This allows you to change up your loan term, get a more competitive rate — or both. Generally, you need to have at least a year of repayment history and excellent credit to qualify.

Student loan consolidation usually refers to a federal Direct Consolidation Loan, which you can use to consolidate multiple federal student loans into one. It won’t change your rate, but it can help you qualify for more repayment and forgiveness options. But it’s not available for private student loans, only federal.

5 reasons you may have been denied for debt consolidation

There are several reasons your debt consolidation loan application might have been rejected — even if you thought you had strong personal finances. Often you can find out why you’ve been rejected by contacting your lender. It likely denied your application for one of the following reasons:

1. Outstanding debt

It can be difficult to qualify for a debt consolidation loan if you have a large amount of outstanding debt, like federal student loans. Even if you don’t plan on consolidating all of these debts, they could still hurt your application.

This might come as a surprise to borrowers on an extended or income-based repayment plan, which gives them a low debt-to-income ratio (DTI). But any large loan in your name gives you a high credit utilization ratio, which lenders tend to view unfavorably.

2. Insufficient income

Borrowers with a debt load within the lender’s range might get rejected because they don’t bring in enough money each month. Generally, if your debt is worth more than half of your annual income, you won’t be able to qualify for a loan.

Lenders also look at your DTI, which weighs your monthly debt obligations to your monthly income. A DTI of around 20% is typically considered good. Most lenders don’t work with borrowers that have a DTI of over 43%.

What’s my DTI?

3. Low credit score

Most lenders have a minimum credit score requirement — even if they don’t advertise it.

If your credit score has taken a dive recently, you’ll have trouble getting approved for any type of loan. Even if you can, you likely won’t get approved for one with more competitive rates and terms than what you already have.

4. Insufficient credit history

Lenders prefer borrowers who have an established history of paying off debts on time — some even have a minimum requirement of at least three years.

If you’re new to borrowing and repaying debt, you might want to fatten up your credit file by applying for a credit card or credit builder loan before taking out a debt consolidation loan.

5. No collateral to back your loan — or not enough

Some debt consolidation lenders require you to back your loan with collateral. If your personal assets are insufficient to secure your loan, your application could get rejected — even if you meet all of the other criteria.

Personal vs. debt consolidation loans

You can use any personal loan for debt consolidation. But some lenders specialize in debt consolidation, specifically. Often these companies pay off your creditors directly and are easier to qualify for with a high debt load.

Balance transfer credit cards vs. debt consolidation loans

Balance transfer credit cards can offer exciting perks, like 0% interest for a year or more on transferred balances. But you face a high revert APR if you’re not able to pay off your debt within the intro period.

A balance transfer credit card could be a suitable way to consolidate debt if you’re certain you’ll pay off your consolidated balance within a year. If you need more time, a debt consolidation loan could be a better deal because the interest rate is lower.

Keep in mind that getting a balance transfer credit card will add another account to your credit utilization ratio, so you’ll want to consider the limit you’re approved for. On the other hand, debt consolidation loans won’t be added to your credit utilization ratio.

What to look for in a service provider

Consider the following factors when comparing financial services companies:

• Accreditation is a strong start. Most legitimate companies that negotiate with creditors are accredited by either the American Fair Credit Council (AFCC) or the International Association of Professional Debt Arbitrators (IAPDA).
• Check that it’s not on the FTC’s list of banned companies. Because there are scams in the debt relief world, you should check the FTC list of companies and people banned from providing these negotiation or settlement services before you sign up for any program.
• Transparency is also a good indicator. If you can’t find vital information like how much a program costs, how fees are calculated, and how long the company has been in business, consider working with another provider.
• Costs should be within a reasonable range. Financial services companies often charge a fee for either a percentage of the total amount of debt you have or the amount they’re able to reduce your debt by. Most credit counseling services are free, though some may charge a small fee depending on your state.
• Whether the company uses direct or indirect negotiation can be a tell. Look for a provider that negotiates with your creditors directly. Indirect negotiation is uncommon and may put your information at risk when it’s transferred between companies.
• Eligibility determines whether applying is even an option. Many companies have restrictions on your total debt balance, types of debt, and where you live. And some are geared toward different credit scores and income ranges.
• Customer reviews on sites like the BBB and Trustpilot are a good place to look out for red flags and learn what you can expect from a provider.

Beware of scams

Many companies that negotiate with creditors for a fee are legitimate. But there are scams out there. It should set off alarm bells if you see a company committing any of these offenses:

1. It charges upfront fees for its services.
2. It guarantees a specific amount of debt savings.
3. It promises it can settle lawsuits and stop calls from collection agencies.
4. It advertises itself as a new government program that can erase your debt.

It also pays to be aware of your state laws. Ensure that any company or attorney you’re working with holds the appropriate licenses and follows state regulations.

When is debt consolidation a good idea?

It may be a good idea if …

• You want to pay off debt over several years. If your plan is to get out of debt right away, a balance transfer credit card could help you save the most.
• You owe less than 50% of your income. If you owe more, you likely won’t qualify and might benefit from other solutions.
• You have fair credit or higher. Your options are limited if you have a credit score below 580.
• You have regular income. You need to prove you have the money to pay off the loan before you get approved.
• You have a plan to stay out of debt. It could hurt your credit if you end up in more debt after consolidating. Make sure you have an emergency fund and budget to avoid this.

It may NOT be a good idea if …

• You have too much debt and bad credit. If your debt is worth more than half of your income or you have bad credit, bankruptcies or foreclosures, you likely won’t qualify. And even if you did, you may get a high rate and monthly repayments that may fall outside of your budget.
• You have no plan to stay out of debt. Debt consolidation may not help if you don’t have a plan to reduce your spending — unless your debt is from a one-time emergency expense. If there’s nowhere left to cut back, other options like credit counseling could be a better choice.

Can I consolidate my debt with bad credit?

It’s possible to consolidate your debt with bad credit. Some lenders provide debt consolidation loans to individuals with less-than-perfect credit. In these cases, the APR you qualify for may not be as low as for someone with better credit.

Other options like 401(k) loans, secured personal loans and HELOCs might be easier to qualify for. But you risk losing your collateral, retirement funds or even your home if you can’t repay. And generally, balance transfer credit cards aren’t available to bad credit applicants.

Does debt consolidation hurt your credit?

Generally, it won’t hurt your credit unless you continue to rack up debt. When you apply for a personal loan, your lender will do a hard pull of your credit to confirm you qualify. This will likely lower your score by a few points for up to 12 months— but it will likely bounce back after a few months of on-time payments.

In fact, consolidating debt can often improve your credit. And the lower your score, the more impactful it will be. A 2019 TransUnion study found that some 85% of borrowers with poor credit saw a 20% increase or more after consolidating debt — only 15% of borrowers with the highest credit scores saw this kind of increase.

Your credit score might decrease if you continue to use your credit cards after consolidating them. The new FICO scoring model — which most creditors use — will penalize borrowers who consolidate debt and then continue to rack up credit card bills. It might also decrease if you miss payments on your new loan. But provided you keep up with your finances, you’re unlikely to see a big decrease in your score with a debt consolidation loan.

Debt consolidation for service members

Look for offers for service members and veterans. Often these have lower rates and more favorable terms than your average personal loan. Especially if your credit is less than perfect.

If you enter active duty, talk to any of your current creditors, too. Your rates may be lowered in accordance with the Servicemembers Civil Relief Act.

Debt consolidation alternatives

If debt consolidation doesn’t seem like the best option for you, consider one of these alternatives.

• Credit counseling. Set up a free meeting with a financial adviser to go over your options and come up with strategies to get out of debt at a credit counseling agency.
• Debt management. Have a credit counseling agency negotiate with your creditors to reduce your interest rate and monthly payments and set you up with a debt management plan.
• Debt settlement. Sign up to have a debt relief company negotiate down your balance for a debt settlement or work with your creditors directly in an attempt to lower your balance.
• Bankruptcy. Best saved as a last resort, you can file for Chapter 11 or 13 bankruptcy to have a judge either eliminate or reduce the amount you owe to your creditors.

The FTC recommends assessing your finances and contacting your creditors before looking into debt consolidation alternatives. If you’ve been rejected for debt consolidation, find out why before you turn to alternatives. You might qualify in the near future by paying off your debts or taking steps to boost your credit score.

Do-It-Yourself options

If you don’t qualify for debt consolidation, you may be able to handle your debt on your own with determination and a manageable budget.

• Repayment strategies can give you a solid framework. It won’t result in a reduction to the amount you owe, but you can adopt a repayment strategy like the debt avalanche or snowball to build your budget and pay off your debts in manageable chunks.
• DIY negotiations may help you get a handle on your debt. Financial services companies negotiate on your behalf, but you can reach out to your creditors on your own. Explain your situation and see if you can lower the amount you owe or modify your repayment schedule.

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Bottom line

Debt consolidation can be a great option if you’re looking for lower rates or more manageable repayments. If that’s the case, you can learn more about how to apply and what to expect by reading our guide to personal loans.

But it’s not ideal if you have poor credit or a high DTI. In that case, you might want to consider other debt relief options.