Debt consolidation is when you take multiple forms of debt, usually high-interest products, and combine them into one single monthly payment. Debt consolidation is a good option personally if it means you can get a lower monthly interest rate compared to all of the debt products on their own. It also organizes your debt so you can see it all in one place instead of it being in multiple places.
If you can easily manage your debt each month and just want to reorganize your range of bills into one easy place that has the same due date and interest rate, then debt consolidation is also a good option.
How Can I Consolidate My Debt?
You can consolidate your debt in two main ways – both of which are about consolidating debt into one place.
- Get a 0% interest balance credit card and transfer your debt. After you register for the card you can move all of your debt onto this card. At the end of the promotional period, you’ll need to pay off the balance. To get one of these credit cards you’ll typically need an excellent or good credit score (690 or above) to qualify for this.
- Find a fixed-rate debt consolidation loan. When you sign up for this type of loan you will take the bulk payment that they give you and use it to pay off the full balance for each of your debts. This means that you’ll only have one loan remaining that should be more manageable. If you have bad or very bad credit (689 and below) then you can still qualify for this type of loan. However, if you have good credit you’ll typically get the best rates.
There are two further ways to consolidate your debt – a Home Equity Loan or a 401(k) loan. These are the two most risky types of debt because they could impact your home or retirement.
When Is Debt Consolidation A Good Option?
If you want to go down the debt consolidation route then you need the following to make it a smart move:
- Your monthly debt repayments including what you pay on rent or mortgage exceed 50% of your gross income.
- You have a credit score that is high enough to qualify for a debt consolidation loan or balance transfer credit card.
- You make enough money each month to cover your debt repayments consistently.
- If you go down the consolidation loan then you need to be able to pay it off within 5 years.
If you’re wondering when debt consolidation makes sense then here is a good example. If you have five credit cards and the interest rate ranges from 17.5% to 26.99%. Your credit is ok because you always pay your bills on time. You could qualify for unsecured debt consolidation at around 7.5% – a much lower rate than what you’re paying on your credit card interest.
Taking out a debt consolidation loan shows a light at the end of the tunnel for most people who decide to go down this route. If you decide on a four-year product then you know the debt will be gone after this time frame, as long as you make on-time monthly payments and you don’t build up more debt. However, if you decide to go down the credit card route you might not be able to repay it for months or years. And at the same time, you might gather more interest and debt on these credit cards.
When Is Debt Consolidation Not The Right Option?
Consolidating debt is not the right option for everyone and isn’t always the silver bullet that you think it might be. It only addresses the current debt that you have, not the spending habits that have got you here in the first place. It also won’t work if you’re swamped by debt and the debt payments still won’t be manageable even if you consolidate.
It’s also not the right option if your debt load is small and manageable. If you can repay it in half a year to a year at your current repayment schedule, then it would probably only save you a negligible amount if you consolidate.
If you do want to change your debt repayment strategy you could use the snowball or avalanche method to pay off debt.
If the total amount of your debt is over 50% of your income and even when consolidating it will still be over 50% of your monthly income, then you should look to get debt relief instead.