How Does Debt Consolidation Work?

If there’s one universal truth about debt — it’s a lot easier to get into it than out of it. Whether you’re dealing with multiple credit card balances, student loan payments, or other monthly bills, paying off your debt can feel overwhelming at times. 

For many bothered borrowers, debt consolidation may be the answer to simplifying debt repayment, while also saving time and money in the process. What exactly is debt consolidation, however, and what can it do for you?

How Debt Consolidation Works

As the name implies, debt consolidation is the process of consolidating (i.e., combining) two or more debts that you hold, into one account. Debt consolidation for consumers typically involves taking out an unsecured personal loan to pay off existing debts. You then repay your consolidated debt amount according to the new loan’s terms and conditions.

You can choose to consolidate all of your debt or select a handful of accounts you want to focus on. For example, you might consolidate all of your credit card balances, but leave your auto loan in place, depending on which debt is most urgent to pay off or has the highest interest rate. 

Let’s say you have three credit cards with a total debt of $30,000 between them. In this case, you’ll need to take out a $30,000 debt consolidation loan in order to pay off all three accounts. In the end, you’ll owe the same amount in principal debt balance ($30,000) ― so why bother consolidating in the first place?

Benefits to Consolidating Debt

There are many reasons you may want to consider debt consolidation, especially if you have high-interest debt like that of credit cards. Here are some potential benefits of consolidating your debt with a personal loan. 

Simplification: Consolidating debt makes the repayment process simpler to manage. Rather than keeping track of multiple due dates, grace periods, late fees, and minimum payment amounts, you’ll only need to focus on the monthly payment for one singular loan. 

Lower interest rate: Perhaps the most common reason for consolidating debt is to pay less interest. By replacing multiple credit card balances with a personal loan, at a potentially lower interest rate, borrowers may be able to save hundreds (even thousands) of dollars over the course of their repayment. As credit cards typically have higher interest rates than personal loans, consolidating will net a borrower a lower APR based on their creditworthiness and other individual factors.

Get out of debt sooner: As noted, debt consolidation may reduce your interest rate. As a result, by maintaining a similar monthly payment amount, a borrower can eliminate their debt sooner by consolidating.

Adjust monthly payments to fit budget: If you’re struggling to make all of your monthly payments on time and in full, debt consolidation can potentially free up some funds. You can choose a loan term and monthly payment amount that works best for you, based on your needs. A longer repayment plan, while ultimately costing more in total interest, can lower your monthly payment and set aside funds for other parts of your budget. 

Remove a co-signer: If needed, debt consolidation allows you to remove a co-signer from one of more accounts. Since you will be paying off existing accounts with a new loan, your co-signer’s obligation to the prior debt will be eliminated.

Debt Consolidation vs Debt Consolidation Programs

It’s important to point out that there is a difference between consolidating your debt and participating in a debt consolidation program, or taking out a debt consolidation loan from a debt relief agency. 

Debt consolidation programs and agencies often have a bad reputation. While these programs may offer financial counseling to help guide you through the process of paying off your debt, they also come at a potentially steep cost. Fees can be significant in some cases, too.

By consolidating your debt with a personal loan, you can eliminate unnecessary or hidden fees while still achieving the same goal, and with a potentially lower interest rate. 

Bottom Line

Consolidating your debt can be a great way to potentially reduce your overall interest rate, streamline the repayment process, and even get out of debt sooner. Be sure to research your existing debt accounts to see how much you owe, what your varying interest rates are, and what you can afford to pay each month before consolidating your balances.