Key insights:
- Debt consolidation can simplify repayment by combining multiple debts into 1 monthly payment, ideally at a lower interest rate
- Before consolidating debt, borrowers should calculate what they owe and compare available offers
- Benefits of debt consolidation may include easier payment management, possible interest savings or faster payoff
- Before consolidating debt, it’s important to review the eligibility requirements and potential fees that come with the method you choose
Consolidating debt can be a useful way to save money while simplifying your monthly payments. The key is finding a loan with a lower annual percentage rate (APR). However, finding an option that works for you requires some research and an understanding of how these options work.
Let’s take a closer look at debt consolidation, including how it works, the pros and cons, and how to decide if it’s right for you.
How does debt consolidation work?
Debt consolidation can help simplify your monthly payments and reduce your overall debt burden, but it’s important to understand how consolidating debt works before you take this step.
The main goal of debt consolidation is to make your debt more manageable. To consolidate debt, you take out a personal loan or line of credit, such as a credit card or home equity line of credit (HELOC), and use it to pay off your existing debts. Ideally, the new loan or line of credit should have terms that work better for you, such as a lower interest rate or lower payments.
How to consolidate debt in 4 key steps
Debt consolidation starts with understanding how much debt you have and your average interest rate. Then you can figure out an affordable monthly payment and evaluate your debt consolidation options.
1. Calculate how much debt you have
Figuring out how much you owe is a critical first step in consolidating debt. Start by gathering information of all of your current debts and their monthly payments. Next, add up the total sum of each account and monthly payment you want to consolidate. You can use a spreadsheet or debt consolidation calculator to help.
This will provide a baseline against which to compare your options later on, helping you implement a plan that fits your budget and determine how much you can borrow.
2. Determine your average interest rate
Each of your credit card balances and other debts will likely have a different interest rate. Find the average rate by adding all the interest rates and dividing by the number of rates. This can help you determine whether the interest rate you’re offered is better than the average rate you’re currently paying.
3. Identify an affordable monthly payment
For many, a key benefit of debt consolidation is getting a more affordable monthly payment. You should weigh the amount you pay each month against your household budget and your spending on necessities such as food and utilities. You could use an online debt consolidation calculator to estimate what your new monthly payments could be.
4. Evaluate your debt consolidation options
There are many options for debt consolidation. Here are some common choices:
- Debt consolidation loan: A debt consolidation loan is a personal loan used to pay off other debts
- Credit card balance transfer: A credit card balance transfer lets you move existing credit card debt onto a new credit card, usually with a low introductory APR
- Home equity loan or HELOC: These are secured forms of credit that use the equity in your home as collateral
Each method has advantages and disadvantages, so carefully review the details of each to find the best option for you.
Pros and cons of consolidating debt: Is it right for you?
Debt consolidation can be a powerful tool, but it isn’t necessarily right for everyone. It’s important to consider the pros and cons before applying.
Debt consolidation advantages
- Potentially lower interest rates: Interest rates may vary across the loans you owe money on. Consolidating debts into 1 payment means you’ll have a single interest rate, which could potentially save you money in the long run if that interest rate is lower than the average interest rate of your previous loans. But keep in mind that with a longer repayment period you may end up paying more in interest.
- A single monthly payment: Figuring out how best to pay off multiple debts with different interest rates can be inefficient and confusing. Consolidating debt into 1 monthly payment with a single interest rate not only simplifies the process but may also allow you to plan more effectively since you’ll know when the debt will be paid off.
- Faster debt payoff: By consolidating debt into 1 payment with a lower interest rate, you could reduce the total amount you owe and pay it off sooner. The faster you pay off your debt, the less interest you will pay over time.
- Credit improvement: Consolidating credit card debt could lower your credit utilization ratio, which measures how much available credit you use. It could also improve your payment history if you consistently make on-time monthly payments. Both factors are crucial in improving your credit score.
Debt consolidation drawbacks
- You must meet certain standards to qualify: Lenders each set their own credit and income requirements for loan approval. If you don’t meet a lender’s credit qualifications, your options may be more limited.
- You may pay fees: Some debt consolidation loans charge origination fees, which will add to your total debt cost. There can also be other fees, such as late payment fees, balance transfer fees and prepayment penalties, depending on the lender.
- Missing payments could hurt credit score: While on-time payments can help to improve your credit score, missing a payment on the debt consolidation tool you choose may result in a credit score dip.
Get help consolidating debt with a personal loan
If you decide to consolidate your debt with a personal loan, you could research banks, online lenders and credit unions to find a loan that meets your needs.
For example, Citi® offers flexible personal loans to qualified applicants. You may even receive a 0.25% discount on the loan APR when you enroll in automatic payments.
Think you could benefit from a Citi® Personal Loan? Apply online today to explore your options.
Consolidating debt FAQs
How does debt consolidation affect your credit score?
Consolidating debt can affect your credit in several ways. While a hard credit inquiry and a lower credit account age can cause a dip in your credit score, paying off your debt and making on-time payments can lead to an increase.
What are the risks of debt consolidation?
If you fail to repay your monthly payment on a debt consolidation loan, you risk defaulting on the loan. That means the lender could charge a penalty, such as a late fee, and the account could eventually go to collections. Your credit score will also be damaged, which may make it harder to apply for and get approved for loans in the future.
Does debt consolidation work on a limited income?
Debt consolidation may be a good option for people on limited incomes. Just make sure the payment and interest rate work for your situation, to avoid taking on additional debt.
What type of debts or loans can I consolidate?
Several types of debt, such as credit card debt and unsecured personal loans, may be eligible for consolidation. Check with your lender first to see what types they allow you to consolidate, as rules may vary.
Do I have to consolidate all of my debt?
No. Debt consolidation is often most helpful for high-interest debt, however. A popular goal of debt consolidation is to lower your interest rate, so if you have lower-interest-rate debt, you may choose to exclude that from debt consolidation.
This article is for educational purposes. It is not intended to provide legal, investment, or financial advice and is not a substitute for professional advice. It does not indicate the availability of any Citi product or service. For advice about your specific circumstances, you should consult a qualified professional.
