Are you feeling overwhelmed by multiple debt payments each month and wondering if you’re overpaying? Enter — debt consolidation.
By consolidating multiple debts into a single new loan or credit card, many borrowers can streamline their payments and reduce their borrowing costs.
But is the move right for you? Here’s a look at the ins and outs of debt consolidation and when it can be a good idea.
What does debt consolidation mean?
Debt consolidation refers to combining multiple debts into a single, larger debt. It involves using a debt consolidation loan or credit line to pay off two or more smaller debts. For example, getting a $10,000 personal loan and using it to pay off $5,000 in credit card debt and $5,000 in medical bills is considered debt consolidation.
Consolidating debt can be beneficial if you can get a lower interest rate than what you have on your existing accounts.
Debt conslidation example
For example, say you have $5,000 of credit card debt across three credit card accounts that have an average annual percentage rate (APR) of 25%.
With monthly payments of $250, it will take you 26 months to pay off the balance, and you’ll pay $1,380 in interest. On the other hand, if you get a debt consolidation loan with a 15% APR and make the same $250 monthly payments, you could pay off the $5,000 balance in 23 months and would pay just $713 in interest.
Consolidating debt can also streamline your repayment process, as multiple payments each month can be stressful, time-consuming, and lead to multiple late fees if you miss payments.
Types of debt consolidation loans
You can consolidate debt in a few different ways, including through balance transfer credit cards, personal loans, or home-equity-backed loan products.
Balance transfer credit cards
A balance transfer credit card allows you to move an outstanding balance from an existing credit card over to the balance transfer card, often for a fee of 3% to 5% of the transfer amount.
But when are balance transfer cards good for debt consolidation? They can be helpful if you have outstanding balances on multiple credit cards and can get approved for a new card with an interest rate that’s lower than the rates on your existing cards.
No-interest introductory periods may also be a good idea. However, be mindful of the promotional term and the normal APR after the promotion ends. If you can’t pay off your debt balance during the introductory period, you’ll be charged interest on the outstanding balance at the card’s standard rate.
For example, say you have a $2,000 credit card balance with a 29.99% APR and are making $140 monthly payments — you would pay off the balance in 18 months and pay $436 in interest.
If you get a balance transfer card with an 18-month 0% APR promotion and 5% balance transfer fee, you could make the same $140 monthly payment, but pay the new balance off ($2,100) in 15 months, and save $336.
Personal loans
Personal loans, sometimes referred to as debt consolidation loans, are lump sum installment loans that you repay through monthly payments over a set term, such as five years, plus interest and fees. Many financial institutions offer them, including banks, credit unions, and online lenders.
Available loan amounts often range from $1,000 to over $100,000 and terms typically range from two to seven years. Plus, lenders can send loan funds to your creditors directly, and may even discount your rate for it.
Personal loans can be a good option if your credit is in decent shape. They’re usually unsecured, so approval will depend heavily on your credit profile. Shop for loans online and get prequalified with multiple lenders to see what APR and terms you might qualify for.
Once you prequalify, compare loan amounts, APRs, fees, loan term lengths, monthly payment amounts, overall costs, funding times, and customer satisfaction ratings between lenders. For example, if time is of the essence, choose lenders with quick funding times.
Note that prequalification is not an offer of credit, but gives the lender (and you) an idea of what you might qualify for based on your credit profile. You’ll need to formally apply once you decide which lender to go with. The lender will conduct a hard credit inquiry when you apply which could temporarily ding your score.