Managing debt can be a difficult task, particularly if it has a high interest rate. Debt consolidation is the process of replacing one or more existing debts with a new one, generally with the goal of securing a lower interest rate, simpler payment plan, lower monthly payment or other more favorable terms.

Depending on the type of debt you have and your credit situation, there may be different options available to you – even if you have bad credit. Here’s everything you need to know about debt consolidation and how to do it.

What Is Debt Consolidation?

Debt consolidation involves paying off one or more existing debts with a new loan or credit card, preferably with a lower interest rate, lower monthly payment or other terms that work in your favor.

By combining multiple balances into one, you can simplify your debt payoff plan and potentially save time and money. Even if you only have one loan or credit card balance, consolidation may still save you money and help you pay off your debt faster.

What Debt Consolidation Options Are Available?

Depending on your situation and goals, there may be several ways you can consolidate your high-interest debt. Consider the advantages and disadvantages of each option to determine which one would work best for you and your debt payoff strategy.

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Debt Consolidation Loan

Debt consolidation loans are personal loans that consumers use to consolidate their debt.

“If you have high-interest or variable-rate debt, especially if it’s made up of balances on multiple credit cards, a personal loan for debt consolidation could allow you to pay off your debt at a lower rate and in less time,” says Matt Lattman, vice president of personal loans at Discover.

For starters, personal loans have fixed repayment terms and can offer a lower interest rate than credit cards. According to the Federal Reserve, the average interest rate on a two-year personal loan was 11.21% in November 2022, which was almost half of the average credit card interest rate of 20.4%.

Balance Transfer Credit Card

Balance transfer credit cards, which are typically designed for people with good credit, offer introductory 0% annual percentage rates on debt transferred from another card or loan. Depending on the card, you may get this rate for anywhere between 12 months and 21 months.

A balance transfer card can be a great way to pay off all, or at least a big chunk, of your debt. But if you have a balance remaining at the end of the promotional period, the card’s regular APR will kick in, so you’ll need to be disciplined in making payments to avoid repeating your present situation. Also, balance transfer cards typically charge an upfront fee of 3% to 5% of the transferred amount, so keep that cost in mind as you compare options.

Home Equity Loan or Line of Credit

If you own a home and have a significant amount of equity, you may be able to take out a home equity loan or a home equity line of credit, also called a HELOC, to consolidate credit card, personal loan, auto loan or any other type of debt.

home equity loan is an installment loan that you pay off over a fixed amount of time. A HELOC is a revolving line of credit, similar to a credit card, that has a draw period when you can borrow from the account – during which you usually pay interest only – and a fixed repayment period.

Home equity loans and HELOCs typically charge lower interest rates than consolidation loans because they’re secured by your home. But they may also charge closing costs, which eat into your savings. Also, these options carry more risk than other debt consolidation choices because if you default on your payments, the lender can foreclose on your home.

You may qualify for a home equity loan or HELOC with a credit score of 620 or above, but the higher your score, the better your chances of securing a low interest rate.

401(k) Loan

Taking money from your 401(k) retirement account to pay off any kind of debt can be appealing if your credit is in poor shape, because there’s no credit check involved. That’s because you’re technically borrowing from yourself, and both the principal and interest you pay on a 401(k) loan go back into your retirement plan.

However, not all 401(k) providers offer this option, and how much you can borrow depends on your balance. What’s more, if you can’t pay it back on time – generally, borrowers must repay the loan within five years – the remaining balance will be treated as an early distribution, which may result in a 10% penalty fee and income taxes.

Debt Management Plan

With a debt management plan, a credit counseling agency can potentially help you secure lower interest rates and lower payment amounts. You’ll make one monthly payment to the agency, which then distributes the funds to your creditors.

You’ll typically pay modest upfront and ongoing fees throughout the three-to-five-year repayment plan, but it can be worth it to keep your finances under control. Plus, there’s no credit check. Note that you may need to close your credit card accounts, which can impact your credit score by increasing your credit utilization rate, until you pay down the balances.

Student Loan Consolidation

With student loans, consolidation typically only refers to the Direct Consolidation Loan program offered by the U.S. Department of Education. If you were to consolidate your loans with a private lender, that’s known as student loan refinancing.

  • Federal consolidation. With the Direct Consolidation Loan program, you can consolidate one or more federal student loans to take advantage of a single monthly payment, a longer repayment term – up to 30 years – or other federal loan benefits that you don’t currently qualify for. There’s no credit check required, but you can’t get a lower interest rate with this option..
  • Private refinancing. Student loan borrowers can refinance both federal and private student loans with a private lender, with the goal of obtaining a lower interest rate, a shorter or longer repayment period – typically between five and 20 years – or a lower monthly payment. However, your eligibility and loan terms depend on your credit and financial situation. Also, refinancing federal student loans will cause you to lose access to federal benefits, such as loan forgiveness programs.

When Is Debt Consolidation Worth It?

Debt consolidation can be worth it if you have high-interest debt or you’re struggling to keep up with your monthly payments.

“If you have several loans to pay off, consolidating to a single loan might make it easier to keep track of everything,” Lattman says.

But depending on your credit history and financial situation, some debt consolidation methods may not be worth it, or they may not be an option at all. Take your time to research each approach and consider the pros and cons for your situation.

If you decide to move forward with debt consolidation, it’s important to evaluate your spending and make changes to avoid putting yourself in this position again. While closing your credit card accounts may not be necessary, for instance, you may choose to cut them up or remove them from your online accounts to restrict your spending.

“I have seen many people consolidate their debts into a loan and continue to run the credit cards back up,” says Kendall Meade, a certified financial planner for SoFi. “This usually makes it harder for them to get out of debt, as they are left with double the payments to worry about and fewer options to consolidate again.”

Debt Consolidation Alternatives

If using another credit card, loan or program to consolidate your debt isn’t the right fit for you, here are some other potential options:

  • Debt snowball method. With this debt payoff approach, you’ll pay the minimum amount on all of your debts and add any extra money you can afford to your payment on the account with the lowest balance. Once that balance is paid in full, you’ll add the total amount you were paying to the minimum payment on the account with the next-lowest balance. You’ll keep doing this until you’ve paid off all your debts. “I like this method because it keeps people motivated and helps them see progress quicker,” Meade says.
  • Debt avalanche method. Similar to the debt snowball method, the debt avalanche method targets your accounts with the highest interest rates first, instead of the lowest balances. You may opt for this approach if you want to maximize your interest savings.
  • Debt settlement. If you’re behind on your payments, debt settlement involves negotiating with your creditors to pay less than what you owe to settle the debt. Keep in mind, though, that you may need to make a lump-sum payment, which can take a while to save up. If you hire a debt settlement service, note that its strategies can have a significant negative impact on your credit score. You can try negotiating with creditors on your own before enlisting the help of a debt settlement company or debt attorney.
  • Bankruptcy. If your financial situation is dire and you don’t see any other way out, you may consider bankruptcy as a last resort. Depending on the type of bankruptcy you qualify for, you may be able to get on a restructured payment plan or have your debts wiped out altogether after liquidating some of your assets. Because bankruptcy can wreck your credit, consult with a bankruptcy attorney before approaching this option to ensure that it’s the right move.

While some of these approaches may negatively impact your credit score, it’s important to see the big picture. “Focus on what is best for your financial health as a whole and not solely focus on your credit score,” Meade says. “If you are able to get these debts paid off and make on-time payments, it may actually help your credit score over the long run anyway.”

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