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What are the pros and cons of debt consolidation?
While it can help you save in the short and long run, it won't fix a habit of overspending.
Pros of debt consolidation
From lowering your monthly payments to saving on interest — or both — here are a few benefits of consolidating your debt:
Lower your interest rate
If your credit has improved since you took out your loan, there’s a chance you could qualify for a lower rate by consolidating. Even if your credit score hasn’t improved, a personal loan may be able to give you a lower rate if you’re struggling with credit card debt. That’s because personal loans typically come with lower interest rates than credit cards.
Lower your monthly cost
When loan repayments are stretching your budget thin, consolidating for a longer term will lower the amount you owe each month. This can help you avoid becoming delinquent or defaulting.
Combine multiple payments into one
Rather than keeping track of multiple repayments, debt consolidation allows you to move everything into one. This can make it easier to manage your spending and create a budget.
Switch to a fixed or variable rate
Not only does debt consolidation let you change your interest rate — you can also change the type of interest rate you have.
If you currently have fixed payments but think the market can give you even lower variable rates, you can consolidate with a variable-rate loan or credit card. Or if you’d rather have one reliable cost each month, you can consolidate with a fixed-rate loan.
Not happy with your lender or credit card company? Debt consolidation offers an opportunity to gracefully part ways before your account is fully paid off.
It might improve your credit
A debt consolidation loan can help you maintain a record of on-time repayments — especially if you consolidate with a longer term to lower your monthly cost.
Gives your debt an end date
Consolidating credit card debt with a personal loan helps you commit to a debt repayment plan. Sometimes seeing a light at the end of the tunnel can give you the motivation to get other parts of your personal finances back on track.
Cons of debt consolidation
Debt consolidation isn’t right for everyone. And there are a few costs and risks you should consider before diving in head first.
You could pay more in interest
There’s a chance you won’t qualify for a lower rate. And even if you do, applying for a longer term means there’s more time for interest to add up. In this case, consolidation could cost you more in the long run.
Debt consolidation can come with several fees, which might cancel out any savings.
- Origination fee. Many personal loan providers charge an origination fee of up to 5% of your loan amount, which they often roll into your balance.
- Prepayment penalty. Your current creditors might also charge a penalty for paying off your loan ahead of time. It’s meant to make up for the interest they would have earned if you stuck to the original term.
- Balance transfer fee. If you opt to move your credit card debt to another card, you’ll likely have to pay a fee of around 2% to 5% of each balance you transfer.
It could dig you deeper into debt
Debt consolidation won’t fix long-term overspending or prepare you for an emergency. If you don’t combine it with an effort to curb spending or build an emergency fund, you could find yourself in a hole that you won’t be able to consolidate your way out of. Having too much debt can make it difficult to stay on top of repayments and damage your credit.
Low DTI required for most options
You might not be able to qualify for debt consolidation at all if you have a high debt-to-income (DTI) ratio. If you owe more than 50% of your salary before taxes each month, you likely won’t qualify at all. Having a high DTI can also make it difficult to qualify for competitive rates.
Moving all of your debt into one place means you don’t get to prioritize if you aren’t able to afford your full repayments. Debt consolidation gives you one all-or-nothing payment. And if you consolidate credit card debt with a loan, you won’t have the flexibility of those minimum monthly payments to rely on when money gets tight.
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Pros and cons of different types of debt consolidation
Which type of debt consolidation you choose can affect how much you save — and whether it’s a good move.
Unsecured personal loan
Also known as a debt consolidation loan, an unsecured personal loan doesn’t require any collateral. This option typically allows you to pay off your debt over three to seven years at rates from 6% to 36%.
- Won’t lose any assets
- Lower monthly cost with a longer term
- Pay more in interest with a longer term
- Potential origination fee
- Good to excellent credit required
Secured personal loan
These personal loans require collateral — usually a savings account, certificate of deposit (CD) or other asset with monetary value that your lender can take if you don’t repay the loan. They come with similar rates and terms as a debt consolidation loan. But the collateral offsets the risk for the lender, helping you qualify for a better deal.
- Lower rates with mediocre credit
- Easier to qualify for
- Risk losing assets
- Not as many options as an unsecured loan
Balance transfer credit card
This allows you to move other credit balances into one new credit card. The main draw is that it often comes with a 0% promotional introductory rate for around the first 12 to 21 months.
- Interest-free intro period
- Combine multiple credit card balances into one
- Gives you a debt payment deadline
- High APR after promotional period compared to loans
- Potentially high monthly cost for large amounts of debt
- Balance transfer fee
Home equity loans and HELOCs
Home equity loans and lines of credit (HELOCs) are secured loans that use your home as collateral. They offer some of the lowest rates out there, but you risk losing your home should you default.
- Lower rates by securing the loan with your house
- Good credit not required
- Fixed and variable rates available
- Risk losing home if you default
- Must already have a mortgage
- Expect to pay around 2% to 5% in fees
You can borrow from most employer-sponsored retirement accounts to pay off your debt. These typically come with an interest rate of around 4% or 5%, which you pay back into your 401(k) over five years.
- Lower interest rates
- Borrowing from yourself
- Easy to qualify for with lots of debt
- You could pay early-withdrawal fees if you lose your job
- Lose out on retirement investments
- 401(k) funds lose bankruptcy protection
Student loan refinancing
Student loan refinancing is the closest thing to debt consolidation for student loans — which personal loan providers generally won’t consolidate. Rates can start as low as 2% with terms from five to 25 years.
- Save on interest with a lower rate
- Cut monthly cost with lower rate or longer term
- Switch servicer that handles repayments
- Good to excellent credit required
- Lose benefits on federal loans
- Hard to qualify if you have a high DTI
Debt consolidation can be helpful if you generally have strong finances but want to better manage your debt payments. Learn more about how it works by reading our guide to debt consolidation. Or if you don’t think it’s right for you, consider one of these other ways to manage your debt.
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