When faced with mounting debt, you may consider consolidating the debt to make it more manageable to pay off. Debt consolidation involves rolling multiple debts into a single monthly payment, preferably with a lower interest rate. This can simplify your debt repayment process and potentially lower the amount of debt you owe in the long term.
In many situations, debt consolidation is a good choice. It can simplify bill payments, lower your interest rate, create a reliable repayment timeline, and may improve your credit score. In this article, you’ll learn what debt consolidation is and when consolidating debt is a good idea.
What is debt consolidation and how does it work?
People usually consolidate debt to lower their interest rate and simplify the payment process. Once approved for a debt consolidation loan, you can take steps to consolidate multiple debts into one monthly payment. This will condense your credit card balances and other outstanding loans into a single amount with one interest rate instead of paying off several balances with different interest rates. For many people, condensing debts and interest rates into one amount is more straightforward than keeping track of multiple debts in different places.
Debt consolidation is not limited to credit card debt. In many cases, it can also apply to auto loans, medical debt, or other types of loans.
When is debt consolidation a good idea?
Debt consolidation has pros and cons, which is why it is important to understand when debt consolidation is a good idea and when it’s not. Here are a few factors indicating it might be a good idea:
You have high-interest debts
Debt consolidation is beneficial when facing high-interest debt because you can potentially lower your rates with a debt consolidation loan. Reducing your interest rate by just a couple of percentage points can lead to significant long-term savings.
You have a steady income and high credit score
Lenders that offer debt consolidation loans look for borrowers with a stable income and good credit score. Steady paychecks signal you’re more likely to cover monthly payments. Meanwhile, a high credit score can help you get a low-interest loan and better loan terms.
You have a good debt-to-income ratio:
Your debt-to-income ratio (DTI) compares how much you owe each month to how much you earn. You can calculate this by dividing your total monthly debt payments by your total income before taxes. Many lenders look for a DTI ratio no higher than 43%, with anything lower than 36% considered a safe bet to afford monthly payments.
You dislike managing multiple credit cards and want better terms:
Consolidating debt can streamline debt payments into a predictable monthly payment, avoiding managing multiple credit card balances at once. You may also be able to get a friendlier repayment term and a lower interest rate, which will help you pay off the debt faster and save money over time.
When is debt consolidation not a good idea?
Debt consolidation can make debt repayment more manageable, but that doesn’t mean you should always consolidate. The following are reasons why debt consolidation may not be a good idea:
Your debt amount is small
If you have a small amount of debt that you can pay off relatively quickly and easily, there is no real reason to consolidate. Paying off the debt now may be more beneficial to avoid unnecessary interest.
Your consolidation options don’t offer better interest rates
One primary goal of debt consolidation is to get a lower interest rate. Consolidating may cost you more if the options you evaluate do not offer a lower interest rate.
Some debt consolidation loans come with fees, such as loan origination fees or balance transfer fees. These fees can be hundreds of dollars or more, which can present a financial challenge for some.
The Benefits of Debt Consolidation
Debt consolidation has two primary benefits that can make repayment cheaper, quicker, and more manageable:
Lower Interest Rates
Paying back individual debts with several different rates can ultimately lead to higher interest payments. With debt consolidation, these rates are condensed into one rate, which could save you money over the life of the loan. Keep in mind, though, that you will only pay lower interest if the rate on your new loan is lower than the combined average rate of the debts you’ve consolidated.
Quick and Simplified Debt Repayment
Consolidating debt will lead to one monthly payment for all your debt. After consolidation, you won’t have to worry about multiple due dates for several balances. And since each payment is the same every month, you can more easily plan out your repayment schedule. You’ll know exactly how much to pay and when you’ll finish paying. Quicker repayment also means interest will accrue for a shorter period. The longer your loan term, the more interest you’ll pay.
Types of Debt Consolidation
Debt consolidation comes in many shapes and forms, including:
With this option, you can move your debt from multiple credit cards to a single balance transfer credit card. This is a good choice for people with good to excellent credit because you may be able to save money by mitigating the interest expenses across your credit cards.
Debt Consolidation Loans
A personal debt consolidation loan gathers all your debts into one monthly payment. As with balance transfer credit cards, good to excellent credit is more beneficial because it will typically help secure a lower APR.
Debt consolidation loan requirements vary by lender. These loans usually come with fixed rates, shorter repayment periods, and prequalification procedures that do not impact your credit score.
Debt Management Plans
You can enroll in a debt management plan with a non-profit credit counseling agency that will work with your creditors to try and lower your interest rate and monthly payment. A debt management plan usually creates a 3–5-year repayment plan. Payments go to the agency, which then pays the creditors.
Remember that not every creditor accepts debt management plans, and you won’t have access to credit cards for the duration of the program. A debt management plan could also negatively affect your creditworthiness, making it harder for you to obtain credit in the future.
Debt Consolidation vs Debt Settlement
Debt consolidation and debt settlements are very different. Debt consolidation helps reduce the number of creditors you owe and simplifies the repayment process, while a debt settlement looks to lower the total amount of debt owed.
However, creditors are not legally obligated to accept a debt settlement offer. So, it’s up to you to determine which would be the best solution for you. Remember that debt settlement companies are for-profit entities that usually charge a fee that’s based upon a percentage of your debt.
Debt Consolidation: Is It Worth It?
Debt consolidation may be a good option to make your debt repayments easier and less costly. Citi offers personal installment loans to Citi customers with a Citibank deposit account open for the last 12 months in good standing. If you think you could benefit from a debt consolidation loan and are a current Citibank customer, apply for a personal loan 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.