While every financial situation is different, debt consolidation is an effective way to pay down debts in a faster and more convenient way. Debt consolidation is, essentially, a way that you can combine all of your debt into one single, larger debt. This eliminates the need for multiple payment plans and may reduce your interest rates on outstanding debts. 

However, debt consolidation is not for everyone. Therefore, it is important to learn more about consolidation programs, including the type of debt that can be consolidated, and who is an ideal candidate for debt consolidation. By learning more about consolidation options available, you will be able to make an informed decision, take control of your debt and work towards achieving financial freedom. 

What is debt consolidation? 

Debt consolidation is the practice of combining qualifying, high-interest debts into one single and lower-interest debt. This can be done in multiple ways, including through a debt consolidation loan or by utilizing a balance-transfer credit card. 

If done correctly, debt consolidation could potentially assist you in paying your debt off faster while saving you money on interest costs. However, debt consolidation should be the solution you turn to when you are overwhelmed by debt, as it is not best used when paying off a debt that you will likely be able to pay within a year. Additionally, debt consolidation does not address the spending habits or financial mismanagement that create large amounts of debt in the first place. 

Discover How a Debt Consolidation Loan Works

A debt consolidation loan can be used to pay off all qualifying debts, thus, consolidating your debts into one simple loan. Instead of paying several creditors each month, you will make one loan installment payment each month over a set period. 

Your loan payment will include an amount that will be applied to your principal balance (the amount you owe) as well as a payment towards your interest. Your interest rate will be based upon several factors, including your loan amount, credit score, credit history and your debt-to-income ratio. 

In addition to standard debt consolidation loans, you can also consolidate debt by taking out a 401(k) loan or a home equity loan. However, both of these loan types have more of a substantial risk. For example, if you pay down your debts by taking out a home equity loan, but then default on your new loan, your home can be repossessed. 

Understanding Balance-Transfer Credit Card Debt Consolidation 

Another way to consolidate your debt is by utilizing a zero percent interest balance-transfer credit card. This type of credit card offers an initial promotional period of zero percent interest with a higher interest rate once the promotional period has concluded. 

These credit cards not only provide you with the convenience of only having one payment rather than several but you can also save money if you pay off debt during the promotional zero-interest period. However, you could also potentially owe more money if you are unable to pay down all of your debt before the promotional period has ended due to higher-interest rates. Promotional periods on zero-interest balance-transfer cards typically last between a few months to a year. 

When to Consider Debt Consolidation 

Every financial situation is different. Depending on yours, debt consolidation may or may not be a good option for you. You may be an ideal candidate for debt consolidation if: 

  • Your total debt, excluding your mortgage, does not exceed 40 percent of your gross annual income. 
  • You have a good enough credit score to qualify for either a low-interest debt consolidation loan or a zero percent interest balance-transfer card. 
  • Have debts that have a higher interest rate than the interest rate that you would pay through debt consolidation. 
  • You have a debt-to-income ratio that will allow you to consistently make payments towards a consolidation loan. 
  • You have a plan in place to prevent falling into debt in the future. 

When Not to Consider Debt Consolidation 

Debt consolidation is not for everyone. For example, if you will likely pay off your existing accounts within the next six to 24 months or if you have no hope of paying off your debt, even though consolidation, then debt consolidation probably is not the best choice for you. Debt consolidation could also cost you more money in the long run if the interest rate that you will achieve through debt consolidation exceeds your current interest rates. 

Four Steps to Maximize the Benefits of Debt Consolidation 

If debt consolidation seems like the right choice for you, it is important to take four key steps that can help you pay down your debt efficiently without finding yourself in more debt than you had prior to debt consolidation. 

1. Create a realistic budget. If you intend to utilize debt consolidation to pay down debts, it is important to have a clear and realistic budget before consolidating. Your budget should include household expenses, debts that are not included within your consolidation loan and your new loan payment. You should also keep a little room for excess expenses or for spending money. With a realistic budget, you will have a better idea of how much you can put towards your consolidation loan or card each month as well as how long it will take you to pay down the debt.

2. Stop using your credit cards. In order for debt consolidation to be successful, you will need to stop accruing debt as you pay down the debt you already have. Therefore, you should stop using your credit cards and avoid taking out any new type of loans. In fact, experts actually recommend you to put your credit cards away from where you may be able to use them impulsively. 

3. Compare consolidation options. Like with any type of loan, it is important to review your options when considering a consolidation loan or balance-transfer credit card. You will want to find a loan or card that offers the lowest interest rate possible in order to maximize any savings that you may accrue. Additionally, if you intend to utilize a balance-transfer card, look for one that has a lengthy promotional period before an interest rate begins. 

4. Consider enlisting moral support. Debt, especially large debt, can be difficult to pay down and stay on top of, especially if you are working on improving poor spending habits. Therefore, it is important to enlist the help of moral support from family or friends. This can help you to hold yourself responsible as well as ensure you stay motivated. 

Can student loans be consolidated as part of debt consolidation?

Student loans may be able to be consolidated as part of your debt consolidation plan depending on the amount that you owe. However, if you have federal student loans, your loans likely have a low-interest rate. Therefore, it is careful to consider whether or not you could end up spending more on your student loans than you currently are. 

If you have multiple student loans, you may also be eligible for debt consolidation for those loans through a repayment plan. However, you will not be able to add your other types of debt into this form of consolidation. Repayment plan options can vary based upon your income and the type of loan you have, so it is important to review all of the options available to you before making a decision.