When Is Debt Consolidation A Good Idea?
Miranda Crace7-Minute Read
UPDATED: July 26, 2023
When you’re juggling multiple debt payments – each with different interest rates, balances and due dates – you may feel like you could drop a ball any minute. You may have heard about debt consolidation and think it could simplify your debt repayments, but you should always think through any financial tool before committing to a strategy.
Read our article below and consider if debt consolidation is a good idea for you and your financial situation.
What Is Debt Consolidation?
For those unfamiliar with debt consolidation, it essentially means you can combine all of your debts into a single monthly payment. Consolidating your debt may also give you the chance to lower your interest rate and the amount you owe every month.
Debt Consolidation Vs. Debt Settlement
Debt consolidation and debt settlement can often be confused with each other, but there are important differences between their results. When you consolidate your debt, you’re still paying what you owe, but through different means and terms. Debt settlement allows you to negotiate with your creditors to settle your debt for less than you may owe. Whether you choose debt consolidation or debt settlement is up to you, but consolidating is typically a safer option.
How Does Debt Consolidation Work?
The most common and sure-fire way to consolidate your debt is with a debt consolidation loan, better known as a personal loan. When you take out a personal loan, you use the funds to pay off your existing debt, and then over time repay that borrowed amount under new loan terms. In addition to simplifying your repayment plan, a personal loan will ideally grant you a lower interest rate. If you have the required credit score for a personal loan, you might consider this debt consolidation strategy.
Other Ways To Consolidate Debt
While taking out a personal loan is the simplest way to consolidate debt, here are some other options you might consider.
Home equity loans. Homeowners with enough equity built up in their homes can use a home equity loan for debt consolidation. The main drawback here is that you put up your home as collateral when you borrow against it to pay off your debts. If you default on your monthly payments, you could lose your home. Compared to a personal loan, having to put up collateral may be more than you’d want to risk.
Home equity line of credit (HELOC). Similar to home equity loans, taking out a HELOC turns your home’s equity into a line of credit you can borrow from to pay off your debt. Like a home equity loan, a HELOC requires collateral – such as your home – to secure the loan. If you fail to pay back your credit, you risk a foreclosure on your house.
Balance transfer credit cards. You can take advantage of the 0% promotional interest rate period by moving your debt over to a balance transfer card. This way you can pay off your existing debt while paying nothing in interest, at least for the length of the introductory period. Be sure you can confidently pay off your balance before the promotional period ends, though, or you may face high interest payments on your remaining balance after it ends.
When Is A Debt Consolidation Loan A Good Idea?
Before taking out a debt consolidation loan, consider if any of the following applies to you and your situation:
- You want a lower interest rate.
- You’re trying to manage too many credit accounts.
- You want to improve your repayment terms.
If any of these ring true for you, you may want to consider using a personal loan to consolidate your debt. In order to ensure a successful debt consolidation, be sure that:
- Your credit is healthy enough for a personal loan or another option.
- You have the cash flow to consistently cover your monthly payments.
- Your total debt doesn’t exceed 40% of your gross income.
- You have a plan for paying off your debt.
If this all checks out, then a debt consolidation loan may be just the ticket for you.
When Debt Consolidation Is Not A Good Idea
Debt consolidation isn’t necessarily a cure-all, and you could end up running into more trouble down the road if you jump the gun on it without thinking. Trying to consolidate your debt may not be worth it if any of the following are true:
- Your debt amount is small enough to manage.
- Your consolidation options don’t offer lower interest rates than you currently have.
- Additional fees and upfront costs would negate your potential savings.
- You’re struggling to pay back the amount of debt you already owe.
Think of debt consolidation as moving your debt into a single space. Consolidating your debt won’t make it disappear, but it can give you an easier time of paying it off with newer terms and interest rates. If the benefits won’t outweigh the trouble you’ll go through, we recommend you pass on debt consolidation.
Pros And Cons Of Debt Consolidation
As with many financial decisions, debt consolidation comes with benefits and drawbacks to the process. Review the following pros and cons and decide whether this option is right for you.
Consolidating your debt can benefit you if:
- You will have only one monthly payment to make.
- You could get lower interest rates.
- You can improve your credit score over time.
- You can get a fixed repayment schedule.
There are also a few drawbacks that can come with debt consolidation. Let’s take a look at them.
Final Thoughts: Is Debt Consolidation A Good Idea?
In short, review your situation. Are you juggling too many credit accounts? Do you think you could get a lower interest rate? Want a more simplified repayment schedule?
If you’ve answered “yes” to each of these questions, debt consolidation may be a good idea for you.
And if you’re ready to get started paying off your credit card debt and achieving more, you can apply online for a personal loan today with Rocket Loans®.
Viewing 1 - 3 of 3
How Much Debt Is Too Much, And What You Can Do About It
Having too much debt can make you struggle financially, but how much debt is too much? Learn the different signs to watch for and how you can manage your debt.
7 Mistakes To Avoid When Paying Off Debt
It’s difficult to escape out from a mountain of debt, but we can help! Read our guide for the most common mistakes to avoid when paying off your debt.