If you’re struggling with credit card debt, then debt consolidation may be able to help. Debt consolidation is the process of combining multiple debts into a single loan, which can be easier to manage. Debt consolidation can also lower your interest rates and payments, making it easier to pay off debt. But it’s not the right solution for everyone. It’s important to understand the pros and cons of consolidating credit card debt before making a decision.
A debt consolidation loan can be a great solution to high-interest credit card debt for the following reasons:
If you have high-interest credit card debt, consolidating your debt with a personal loan may lower your overall interest rate. This is because personal loans have lower interest rates on average than credit cards. For example, the average rate on a two-year personal loan was 11.48% in May 2023, according to the Federal Reserve’s Consumer Credit report. In contrast, the average credit card rate was over 20%.
With a lower rate, you may also have a lower monthly payment or a shorter payoff period.
For example, if you owe $10,000 in credit card debt at a 20% interest rate, you could pay it off over five years with a $265 monthly payment (and pay almost $5,900 in interest).
But if instead you use a personal loan to consolidate the debt at a rate of 11%, your payment would drop to $217 per month, and you’d pay just over $3,000 in interest.
| 20% interest | 11% interest | |
|---|---|---|
| Monthly payment | $264.94 | $217.42 |
| Total interest | $5,896.33 | $3,045.45 |
| Number of years | 5 | 5 |
| Total debt | $10,000 | $10,000 |
Instead of juggling multiple payments with different due dates and varying interest rates, consolidating debt with a personal loan or credit card gives you a single payment each month. Managing a single payment could reduce the likelihood of missing payments and incurring late fees.
By combining your debts into one loan or credit account, you can establish a clear debt payoff timeline. When it comes to setting and accomplishing financial goals, clarity is key. Knowing the specific date when you will be debt-free can provide a sense of relief and serve as a powerful motivator throughout your debt repayment journey. You may even want to set benchmarks where you reward your accomplishments, such as paying down half your debt.
Consolidating your debts can also have a positive impact on your credit score. When you consolidate multiple debts, you effectively reduce your credit utilization ratio — the amount of your debt relative to your overall credit limit.
Lowering your credit utilization ratio demonstrates responsible credit management and can boost your credit score over time. Additionally, by making consistent payments on a debt consolidation loan, you establish a track record of reliability, which can further improve your credit score.
| Good to know: Your credit utilization ratio makes up 30% of your FICO credit score. |
Debt consolidation has the potential to help you get out of debt faster, especially if you can secure a lower interest rate than what you’re currently paying. With a lower interest rate, more of your monthly payment goes toward reducing the principal amount you owe. This accelerated debt repayment can shorten the overall duration of your debt and save you big money in the long run.
There are also important disadvantages of debt consolidation to consider:
While debt consolidation offers the potential for a lower interest rate, it’s not guaranteed. The interest rate you qualify for depends on various factors, including your credit score, income, existing debt, and overall financial situation.
If you have a poor credit history or a high debt-to-income ratio, you may not be eligible for an interest rate lower than what you’re already paying. In such cases, debt consolidation may not provide a financial benefit and may not be the most cost-effective solution.
Debt consolidation can involve fees and charges in addition to the interest rate. For example, personal loan lenders may impose origination fees, which could be up to 12% of the loan amount; and credit card companies frequently charge balance transfer fees, which could be up to 5%.
These fees add to your overall debt burden and reduce the potential savings you expect to achieve through consolidation. Carefully review and understand the terms and fees associated with any debt consolidation option before committing to it.
One significant drawback of debt consolidation is that it does not address the root cause of your debt. If your financial difficulties stem from poor money management, overspending, or a lack of budgeting, consolidating your debts will not solve these underlying issues.
Without addressing the behaviors and habits that led to accumulating debt in the first place, there’s a risk of falling back into the same pattern and accumulating new debt while paying off the consolidated loan. It’s crucial to complement debt consolidation with efforts to improve your financial habits and develop a sustainable budget.
“It may make sense to consolidate debt if you can get a considerable break on your interest and will be able to pay it off within a shorter period of time,” said Jay Zigmont, a certified financial planner with a doctorate in adult learning. “If you are consolidating credit card debt, be sure to lock your credit cards so that you don’t take out more debt. It is common for people to max out their credit cards again after debt consolidation.”
If you decide that debt consolidation is your best option, here’s how to get a debt consolidation loan: