What is Debt Consolidation?
Debt consolidation is the financial strategy of taking out a single new loan to pay off multiple existing debts. By combining various balances — such as high-interest credit cards, medical bills, or personal loans — into one payment, borrowers can often secure a lower overall and simplify their monthly repayment schedule.
How Debt Consolidation Works
When you consolidate debt, your total debt amount does not decrease. Instead, you are restructuring how you pay it back. For example, if you have three credit cards with a combined balance of $15,000 at an average APR of 24%, you might qualify for a $15,000 personal loan at a 10% APR.
You use the personal loan funds to pay all three credit cards down to a $0 balance. You now owe $15,000 to the personal loan lender, but your monthly interest charges will be significantly lower, allowing more of your payment to go toward the principal balance. The FTC advises consumers to carefully compare the total cost of a consolidation loan versus paying each debt individually before signing any agreement. Debt consolidation works best when you secure a meaningfully lower interest rate — for example, consolidating $15,000 in credit card debt from 22% APR into a personal loan at 12% APR over 3 years saves approximately $2,800 in interest charges.
Methods of Consolidation
- Personal Loans: Unsecured loans offered by banks, credit unions, and online lenders, typically with fixed interest rates and fixed repayment terms of 2 to 7 years.
- Balance Transfer Credit Cards: Moving existing credit card balances to a new card offering a 0% introductory APR for 12 to 21 months.
- Home Equity Loans or HELOCs: Borrowing against the equity in your home. This typically offers the lowest interest rates but requires you to use your house as collateral.
