How to Consolidate Debt

Every year, many Americans consider rolling their outstanding debts into one manageable monthly payment, usually with a lower interest rate. If borrowers can consolidate their debts to a low-interest loan, they could save money on interest by paying off their debt faster while simplifying the payment process.

Consolidating debt can save you money over time if you consolidate higher-interest debts into a single lower interest loan. In many cases, it’s a sensible financial strategy that can make paying off debt more manageable and affordable.

What is Debt Consolidation and How Does it 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 lower your interest rate and simplify the payment process. Once approved for a personal loan, you can consolidate your high-interest debt, including multiple credit card balances with varying interest rates, into a single monthly payment. Paying off several debts in one amount is sometimes simpler than juggling various balances and interest rates.

Steps for debt consolidation

Calculate how much debt you have

Figuring out how much you owe is a critical first step in consolidating debt. This will allow you to implement a plan that fits your budget and helps you determine how much you can borrow.

Determine your average interest rate

Each of your credit card balances and other debts will likely have a different interest rate. Before you consolidate your debt, use a debt consolidation calculator to determine if you can save on interest by consolidating your debts into a single monthly payment at a lower interest rate.

Identify an affordable monthly payment

The core of debt consolidation is an affordable monthly payment. The amount you pay each month should be weighed against your household budget and what you spend on necessities such as food and utilities. You could use an online debt consolidation calculator to estimate what the monthly payments could be on a personal loan.

Evaluate your debt consolidation options

There are many options for debt consolidation. You may consider a debt consolidation loan or a debt management plan. Each method has advantages and disadvantages, so review the details of each before choosing the option that works best for you.

Advantages of Debt Consolidation

Here are some of the advantages of debt consolidation:

1. Potentially lower interest rates: Interest rates may vary across the loans you owe money on. Consolidating debts into one payment means you’ll have one 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.
2. One monthly payment: Paying off multiple loans with different interest rates can be inefficient and confusing. Consolidating debt into one monthly payment not only simplifies the process but also allows you to plan more effectively since you’ll know when the debt will be paid off.
3. Faster debt payoff: By consolidating debt into one payment with an interest rate lower than the average interest rate on all your loans, 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. 
4. Credit improvement: Debt consolidation 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 monthly payments. Both factors are crucial in improving your credit.

Frequently Asked Questions

How does debt consolidation affect your credit?

Consolidating debt impacts your credit in a few different ways. As stated above, paying off your debt after consolidating could improve your credit. But in the interim, debt consolidation could negatively impact it.

Applying for a loan launches a hard inquiry from your lender into your credit file, which may cause a temporary decline in credit score. Additionally, opening a new credit account lowers your average account age thus lowering the age of your credit history and could impact your creditworthiness.

Is debt consolidation the right choice?

Debt consolidation can be the right choice for responsible borrowers with high-interest debt. It usually lowers your average interest rate and simplifies the payment process with monthly installments.

However, if you have a small amount of debt that can be paid off quickly, there is little reason to consider consolidation. 

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, which means the lender could charge penalty such as a late fee. Your credit score will also be damaged, making it harder to take on loans in the future.

It is also important to keep an eye on fees. Debt consolidation loans may charge origination fees of up to 8% of the loan amount.

Does debt consolidation work on a limited income?

Debt consolidation can be a good option for people on limited incomes. Repaying the debt should still be beneficial as long as the borrower has an affordable monthly payment, can find a low-interest debt consolidation loan, and doesn’t take on additional debt.

There are certainly risks for people on a limited income, especially if that income is not stable. Therefore, it is crucial to ensure your monthly payment is reasonable for your income.  

What type of debts or loans can I consolidate?

Several types of debt can be consolidated. Credit card debt, personal loans and unpaid medical bills can all be consolidated with unsecured personal loans.

Do I have to consolidate all my debt?

Debt consolidation is probably most preferable when you have high-interest debt. One of the main goals of debt consolidation is to lower your interest rate. However, if you want to pay off a debt with a lower average interest rate, consolidating the debt may not be your best option.

Who can help me consolidate my debt?

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.

Citi offers personal loans to existing Citi customers and new Citi customers who meet specific eligibility criteria, including an established credit and income history, along with additional factors determined by Citi. If you think you could benefit from a Citi Personal Loan, apply online today.

Disclosure: 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.