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How Debt Consolidation Works and When It Makes Sense



How Debt Consolidation Works and When It Makes Sense

Hey there! If you’re struggling with high-interest debt across multiple credit cards or loans, debt consolidation may be able to help. I know – debt and finances can be super stressful. But consolidating your debts into one single payment each month can make managing your money a whole lot simpler.

In this article, I’ll walk you through exactly how debt consolidation works, the pros and cons, and when it actually makes sense to consolidate your debts. There’s no one-size-fits-all approach, so let’s dig in!

What is Debt Consolidation?

Debt consolidation basically means rolling all your existing debts into one new consolidated loan, with just a single payment each month. The goal is to make your debt more manageable by:

  • Simplifying multiple payments into one monthly bill
  • Scoring a lower interest rate to pay off your debt faster and cheaper
  • Making it easier to budget and free up cash flow each month

You can consolidate your debts in a few different ways – the most common options are a personal loan, balance transfer credit card, or home equity loan. Let’s break down how each debt consolidation method works:

Personal Loans

With a personal loan, you borrow a lump sum of cash from a bank or online lender. The loan amount covers your total debts, and you pay it back in fixed monthly installments with interest. Personal loans can offer lower rates than high-interest credit card debt.

Balance Transfer Credit Cards

A balance transfer card lets you shift your existing credit card balances onto a new card, typically with a 0% intro APR period. You avoid interest charges for 12-21 months. Just be sure to pay off the full balance before the 0% rate expires.

Home Equity Loans

A home equity loan uses your home equity as collateral to borrow money at a low rate. This can be risky though – if you default, the lender can seize your home!

Now let’s get into the nitty gritty of how debt consolidation loans actually work and what happens when you get one.

How Does Debt Consolidation Work?

Here are the step-by-step mechanics of consolidating your high-interest debts with a personal loan:

  1. Apply for a debt consolidation loan – Provide details on your income, debts, credit score and more. This helps lenders determine your eligibility and interest rate.
  2. Get approved for the loan amount – The lender offers you a loan to cover your total debts, with fixed repayment terms.
  3. Receive the loan funds – The lender deposits the approved loan amount directly into your bank account.
  4. Pay off your existing debts – You use the loan funds to pay off your credit card and loan balances in full.
  5. Begin making payments on the consolidation loan – You now just have a single monthly bill for your consolidation loan payment.

Once approved, the debt consolidation company sends payoff checks to each of your creditors. This settles your balances and closes those accounts. Going forward, you only need to budget for your new consolidated loan payment each month.

The Pros of Debt Consolidation

Debt consolidation offers some nice benefits that can help you tackle high-interest debt:

Lower Interest Rate

The top reason to consolidate debt is to score a much lower interest rate than your existing debts. This saves you money over the loan term and helps you pay off your balance faster. Consolidation loans typically have rates starting around 6% – much lower than the 14-25% APR on most credit cards.

Single Monthly Payment

Instead of tracking multiple credit card and loan payments each month, you’ll have just one predictable consolidation loan payment. This simplifies budgeting and cash flow management.

Fixed Repayment Schedule

Consolidation loans come with fixed repayment terms, unlike credit cards that allow fluctuating payments. Knowing your exact monthly bill for the next 3-5 years makes planning ahead much easier.

Pay Off Debt Faster

The lower rate and fixed repayment plan help you pay off your debt in a more efficient, structured way. No more minimum credit card payments that drag out interest charges.

Improve Your Credit

As you make on-time payments each month, this positive payment activity gets reported to the credit bureaus. Over time, regularly paying your consolidation loan can improve your credit score.

Potential Cons of Debt Consolidation

Debt consolidation loans aren’t perfect though. Here are some of the potential drawbacks to watch out for:

Upfront Fees

Many lenders charge origination fees of 1-5% of the total loan amount. These upfront charges get tacked onto your loan balance.

Prepayment Penalties

Some lenders penalize you for trying to pay off your consolidation loan early. Make sure to check the loan terms for any prepayment fees.

Missed Savings from 0% Balance Transfer Cards

If you have good credit, balance transfer cards with 0% intro APR periods may save you more money than a consolidation loan.

Lengthy Repayment Terms

Personal loans can take 3-5 years to pay off. It’s a long repayment period, compared to aggressive credit card payoff strategies like the debt snowball method.

Credit Inquiries

Applying for a consolidation loan requires a hard credit check, which can ding your credit score in the short-term. Too many rate checks in a short timeframe can be seen as risky behavior.

Collateral Requirements

Secured debt consolidation loans require an asset like a car or cash savings as collateral. Fall behind on payments, and the lender can seize your property.

When Does Debt Consolidation Make Sense?

Here are some smart times to consider consolidating your high-interest debts:

You Have Good Credit

A credit score of 670+ will qualify you for the lowest consolidation loan rates. Excellent credit (740+) gets you the most savings. If your score is lower, focus on credit building first.

Interest Rates Are High

If you’re paying 14%+ interest across multiple credit card debts, consolidation can drastically reduce interest costs. The savings make it worthwhile.

Monthly Payments Are Unmanageable

If you’re constantly late on payments or can’t keep up with minimums, consolidation combines everything into one smoother monthly payment.

You Need Breathing Room in Your Budget

Consolidation can free up extra cash flow each month by lowering your interest rate. This gives your budget some breathing room.

You Want To Pay Off Debt Faster

The structured repayment terms help you pay off debt faster than just minimum credit card payments. Knock it out sooner!

Alternatives to Debt Consolidation

Other options beyond debt consolidation loans include:

Balance Transfer Cards

These offer 0% intro APR periods to avoid interest and pay down debt aggressively without consolidation.

Debt Management Plans

Credit counseling agencies can negotiate lower interest rates on your debts and consolidate payments through a DMP.

Debt Settlement

Debt settlement companies negotiate to reduce your balances, but this stays on your credit report for 7 years.


Chapter 7 bankruptcy liquidates your assets to eliminate debts, while Chapter 13 restructures debts into a repayment plan.

The Bottom Line

At the end of the day, ask yourself:

  • Will consolidation help me pay off debt faster and save on interest?
  • Will the monthly payment be easier for my budget to handle?
  • Is my credit score good enough to qualify for low rates?

If you answer yes to these questions, debt consolidation with a personal loan can make solid financial sense. Just be sure to shop around for the best loan terms and avoid paying any extra fees.

I hope this overview gives you a better understanding of how debt consolidation works and whether it’s the right debt payoff strategy for your situation. Let me know if you have any other questions!

Delancey Street is here for you

Our team is available always to help you. Regardless of whether you need advice, or just want to run a scenario by us. We take pride in the fact our team loves working with our clients - and truly cares about their financial and mental wellbeing.

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