How does debt consolidation work?

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Debt consolidation works by combining several debts into one. This can lower your interest rate and help you get out of debt faster. Learn more. (iStock)

Being in debt can feel overwhelming, especially if you’re juggling multiple monthly payments. Americans had more than $784 billion in credit card debt in 2021, with an average balance of $5,221, according to an Experian Consumer Debt Study.

If you’re struggling to keep all of your debt repayments under control, debt consolidation can be a helpful strategy.

Here’s what you need to know about debt consolidation, how it can benefit you, and how it can affect your credit score.

A personal loan can be a great tool for consolidating high interest debt. With Credible, it’s easy to see your prequalified personal loan rates from various lenders in minutes.

How does debt consolidation work?

Debt consolidation consists of combining several sources of debt into one. To do this, you will usually need to open a new loan or credit card and then use it to pay off your existing balances. Streamlining multiple payments into one can make it easier to manage your debt and may even help you save money in the long run.

For example, suppose you have three credit cards: one credit card has a balance of $5,000 and an APR of 15%, another card has a balance of $2,000 and an APR of 19%, and the last card has a balance of $3,000 with an APR of 21%. % APR. If you allocate a total of $400 to all your balances each month, you will pay $2,748 in interest and it will take you 43 months to pay off your debts.

But if you consolidate your $10,000 credit card balances into a personal loan with a 12% APR and 36-month repayment terms, your monthly payment would be $332. You would pay $1,957 in interest and be debt free seven months earlier.

3 ways to consolidate debt

Now that you have a better understanding of how debt consolidation can benefit you, the next step is to learn how to do it. You have three main options for consolidating your debts, and which one is best for you will depend on the types of debts you have.

debt consolidation loan

Debt consolidation loans are unsecured personal loans that you can use to consolidate your debts. You will apply for a debt consolidation loan from a personal lender. If you’re approved, you’ll receive a lump sum upfront that you can use to pay off your high-interest debt. Some lenders will even pay your creditors directly for you. You will then start making monthly payments on your debt consolidation loan for a set period of time.


  • Usually comes with lower interest rates than credit cards
  • Fixed monthly payments can make budgeting easier
  • Clear end date for loan repayment

The inconvenients

  • May have origination fees for processing the loan or prepayment penalty fees if you repay the loan sooner than expected
  • No introductory interest rate period like some credit cards offer
  • Once you’ve paid off your credit cards with the loan, you may be tempted to make new credit card purchases and rack up more debt.

If you’re looking for a debt consolidation loan, visit Credible to compare personal loan rates from various lenders, all in one place, without affecting your credit score.

Balance transfer credit card

Balance transfer credit cards are designed for debt consolidation. You will apply for the card from a credit card issuer. If you’re approved, you can transfer your existing credit card balances to the new card. Balance transfer cards often come with an introductory APR of 0% for a specified period, and the credit card company may also waive the balance transfer fee during the promotional period.


  • Often comes with a 0% APR introductory offer
  • During the promotional period, you can work on paying down your balance without accumulating additional interest
  • Opening a new credit account can lower your credit utilization ratio (the amount of credit you use compared to the amount of available credit you have)

The inconvenients

  • You generally need good to excellent credit to qualify for a balance transfer credit card
  • May have to pay a fee for each transfer (usually 3% to 5% of the transferred amount)
  • Holding a balance after the promotional period of the card has expired may result in high interest charges


Student loan consolidation

If you have multiple federal student loans, you have the option of consolidating them into one federal direct consolidation loan. Your interest rate will be a weighted average of your existing loans, so it cannot be lower. But you’ll only have one payment to track, which can make budgeting easier.

You can also refinance federal and private student loans into a new private student loan, ideally giving you a lower interest rate. But refinancing federal student loans into a private student loan can cause you to lose some benefits and protections, like income-driven repayment plans and student loan forgiveness.


  • Streamlines multiple loan payments into one
  • You can save money on interest charges
  • Can repay loans sooner if you choose a shorter repayment term (although your monthly payment is likely to be higher)

The inconvenients

  • Choosing a longer repayment term will result in a lower monthly payment, but you’ll pay more interest over the life of the loan
  • Refinancing Federal Student Loans to a Private Loan Will Mean Loss of Access to Federal Benefits
  • May not qualify for private student loan refinance if you do not have a strong credit history or co-signer

Debt Consolidation vs Debt Settlement

Although the two terms are often used interchangeably, debt consolidation and debt settlement are actually two very different methods of debt management. Debt consolidation involves combining multiple balances into one payment, while debt settlement involves settling with your creditors less than the total amount you owe.

Although paying less than you owe may seem tempting, pursuing debt settlement can negatively affect your credit score. If your debt is marked as settled, it may show up on your credit reports for up to seven years, which can make it harder to borrow money in the future.

When debt consolidation makes sense

The main The advantage of debt consolidation is that it can make it easier to manage your payments. And debt consolidation can actually help improve your credit score in some cases by reducing your credit utilization rate and improving your credit mix (the different types of open credit accounts you have).

Here are some scenarios where debt consolidation can make sense:

  • You want to reduce your number of monthly payments. Debt consolidation allows you to combine several monthly payments into a single payment.
  • You want to lower your interest rate. Debt consolidation can get you a lower interest rate, which can help you save money over time.


When debt consolidation doesn’t make sense

Although it can have several advantages, consolidating your debt may not be the best option in these situations:

  • You only have a small amount of debt. If you only have a small amount of debt, it probably makes more sense to focus your energy on making the biggest payments possible rather than shifting your debt or paying extra fees to take out a new loan.
  • You have had success with other debt repayment methods. If you were able to pay off your debts before using a free strategy, such as the debt avalanche or debt snowball methods, you may be able to use those methods again to pay off your debt.

How Debt Consolidation Affects Your Credit Score

Debt consolidation can affect your credit score in different ways. Applying for a new loan or credit card may temporarily lower your credit score at first because the lender or credit card company will perform a thorough credit check to review your credit reports.

Over time, debt consolidation can reduce your credit utilization ratio and can also improve your credit mix, which can increase your score. If you make all your payments on time, it can also increase your score, because your payment history is the most important factor that determines your credit score.

But if you make late payments or miss a payment on your debt consolidation loan, it can negatively affect your credit. If you are tempted to overspend and increase your credit card balances after paying them off with a debt consolidation loan, this will increase your credit utilization, which can also hurt your score. If you’re worried about getting into debt, consider talking to someone at a nonprofit credit counseling agency. A credit counselor can help you budget and provide tools to help you achieve your financial goals.

Getting a debt consolidation loan can be a useful tool to help you get your finances back on track. If you’re ready to apply for a debt consolidation loan, use Credible to quickly and easily compare personal loan rates to find the option that best suits your needs.

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