What is Debt Consolidation?

By Upstart Content Team | Updated November 11, 2014
reading time 5 min read
Man wearing headphones at his desk reviewing papers on debt consolidation.

Key takeaways: 

  • With debt consolidation, you can combine several debts into a single monthly payment.
  • There are different types of debt consolidation methods, such as a debt consolidation loan, a balance transfer credit card, a home equity loan, or home equity line of credit (HELOC).
  • Through debt consolidation, you may be able to save money over the life of the loan if you qualify for a lower interest rate. 

Paying off high-interest debt each month can make it hard to create a realistic budget to reach your financial goals. Regardless of the amount you owe, it can take a long time and a lot of money in interest to get out of debt

You may be able to ease some of your financial stress by consolidating your debt. With this money management method, you can combine several debts into a single monthly payment. Depending on the method you choose, you may be able to get a lower interest rate and lower monthly payments, saving money in the long run.

However, before you make any decisions, it’s essential to do your research to make sure you pick the best option for your financial situation.

Debt consolidation meaning

Debt consolidation is the act of combining your debts into one payment. By consolidating multiple debts into one monthly payment, it can make repaying your debt easier to manage. 

How does debt consolidation work?

When you consolidate debt, you take out a new line of credit or a loan to combine your current credit card debt and loan debt into a single monthly payment. This strategy can help you organize or lower your monthly payments if you qualify for a lower interest rate. 

If you get a low interest rate, you could possibly save hundreds or thousands of dollars in interest. Additionally, having only one payment to worry about can help you avoid late payments, which can hurt your credit.

To be clear, debt consolidation doesn’t erase your debt. You still have to pay back what you borrow. Debt consolidation just simplifies your payment plan.

Debt consolidation requirements

If you’re thinking about consolidating your debt, you’ll need to meet the lender’s minimum requirements. However, the requirements for debt consolidation vary depending on the lender and the method you choose. To get started, focus on these three areas:

  • Proof of a steady income: One of the first things a lender will want to know is if you have a reliable source of income you can use to make your monthly payments.
  • Credit health: To make sure you’re a reliable borrower, lenders will check your credit score and report to understand how well you handle your finances.
  • Ability to offer equity: If you want a larger loan amount, lenders may ask you to back up your loan with an asset you own. 

How to consolidate debt

Two popular ways to consolidate debt are a balance transfer credit card and a debt consolidation loan:

  • Balance transfer credit card: With a balance transfer credit card, you can streamline your loan payments by combining all of your debts onto this card with a single monthly payment. If you can, opt for a balance transfer credit card with an introductory 0% interest rate.You can save a lot on interest by paying off the balance in full (or in part) before the promotional period ends. After the promotional period ends, your credit card will return to its set interest rate, which will increase your monthly payment amount. It’s important to note that depending on the lender you choose, you’ll likely need a good credit score to qualify.
  • Debt consolidation loan: You can also take out a new debt consolidation loan from a bank, credit union, or lending platform to combine all of your debts into a single payment. Because most consolidation loans have fixed interest rates, the monthly payment remains the same throughout the repayment period.This will help simplify your debt payments. If you qualify for a lower interest rate, it could also help save you money over the life of the loan. Even if you have “bad credit,” you may still be able to qualify for a loan.However, borrowers with higher credit scores will likely qualify for the most favorable terms. If you have a low credit score, consider taking the time to improve your credit score before you apply for a new loan.

A balance transfer credit card and debt consolidation loan are not your only consolidation options. You can also consolidate debt by taking out a home equity loan, home equity line of credit (HELOC), or 401(k) loan. 

However, these types of loans are commonly unsecured. This means they need to be backed by collateral or an asset you own such as your home or retirement savings. If you default on your payments, your lender can take ownership of the collateral as payment.

Pros and cons of debt consolidation

If you’re thinking about consolidating your debt, you need to consider the pros and cons. When shopping around for lenders, keep the following pros and cons in mind.

Pros of debt consolidation Cons of debt consolidation
If you qualify for a lower rate, you can pay off your debt faster and save money on interest. Some lenders may charge fees such as closing fees, prepayment penalties, origination fees, and balance transfer fees.
Debt consolidation lets you roll multiple monthly payments into one, which makes it easier to budget. With some lenders, you may not qualify for a lower interest rate.
You could get a longer loan term, which will provide you with more funds in your budget in the short term. If you choose to consolidate into a secured loan, you may need to offer up an item that you own as collateral to back up the loan.
Consolidating your debt can help you pay your existing debt. This can help lower your credit utilization ratio and improve your credit score. Debt consolidation won’t help you manage your spending habits. 

Debt consolidation FAQs

Does debt consolidation affect your credit score?

When you initially consolidate your debt, your credit score may drop a few points since you’re opening a new account. As long as you make consistent on-time payments, your credit score will bounce back and may significantly improve. However, if you miss payments, or if you run up your credit card balances a lot, your credit score will drop.

How long does debt consolidation stay on your credit report?

Consolidating your debt may have a small, temporary impact on your credit report. However, this should not be cause for alarm. As long as you make your monthly payments on time, it’ll likely bounce back quickly. 

This is different from a debt settlement, which will stay on your credit report for seven years starting the day it was settled.

What is the best way to consolidate and pay off debt?

The best way to consolidate your debt is the option that best fits your unique financial situation. In addition to shopping around and comparing your options, base your decision on how much debt you have, the interest rates, your credit health, and if you have home equity.

That way, you can better decide between a debt consolidation loan, credit card consolidation loan, home equity loan, home equity line of credit, or balance transfer credit card. 

What are debt consolidation loan alternatives?

Although debt consolidation loans can be a helpful way to find debt relief, it’s not the only option. Other debt consolidation options include:

The bottom line: Is debt consolidation worth it?

Debt consolidation can be a good financial move, but it’s important to address the reasons and habits that got you into debt in the first place before you apply for consolidation. When you’re ready to start applying, take the time to research all of your debt consolidation options. Then, compare interest rates, fees, and terms before finalizing your decision.

If you feel debt consolidation isn’t the right option for you, consider speaking to a non-profit credit counselor to help you come up with a debt management plan. You can also contact your lender to see if you may be eligible to negotiate a debt settlement.

This content is general in nature and is provided for informational purposes only. Upstart is not a financial advisor and does not offer financial planning services. This content may contain references to products and services offered through Upstart’s credit marketplace.

About the Author

Upstart Content Team

The Upstart Content Team shares industry insights, practical tips, and borrower success stories to help people better understand the important “money moments” of their lives.

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