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If you haven’t been using a budget or watching your spending for the last however many years, then you may find yourself with a mountain of debt and begin to feel like there is no way out.  It can be overwhelming and depressing when you realize how much money you are spending, sometimes just on minimum payments alone, that could be better spent elsewhere.  But, there is hope.  Besides sticking to a strict budget and finding ways to make some extra money you could consider debt consolidation. 

What is Debt Consolidation?

Debt consolidation is exactly what it sounds like.  You are consolidating, or combining, all your debt in order to have one monthly payment and a lower interest rate, making it easier to pay off.  This is most frequently done with credit card debt, which is what we are focusing on, as they tend to have higher interest rates, but it can be done with other types of debt as well.

How Does Debt Consolidation Work?

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Debt consolidation works by taking out a loan or working with a debt management company to reduce your interest rate and combine your payments into one affordable payment.  For it to really work for you, you need to know exactly how much debt you have, the interest rates on that debt, and the minimum payments you are making.  You should also create a budget and look at how much money you have left over after all your monthly expenses to verify you can afford any payment that needs to be made.  If you can’t get a lower interest rate and payment, then consolidating won’t work for you. 

You should also take it one step further and calculate how long it will take you to pay off your debt naturally vs. how long it will take with a loan or debt management program.  If it will take you 3 years to pay off naturally and a loan will take you 5 years to pay off then, even with a lower payment and interest rate, it may not make sense to consolidate unless you are really in deep and need the breathing room.

How Should You Consolidate Your Debt?

There are a few ways you can consolidate your debt including both loan-based and non-loan-based methods.

Debt Consolidation with a Loan

Personal Loan

A personal loan is a traditional loan.  It is what most people think of when they think of getting a loan.  With this method, you would apply for a loan in the amount of your debt and use it to pay that debt off.  You would then put all your efforts into paying the personal loan off.  However, if you are in a significant amount of debt and your credit score has suffered, you may not be able to get a personal loan.

Home Equity Loan

If you own your home and have some equity in it you could use that to get a home equity loan.  Essentially, you would be remortgaging your property in order to pay off your debt.  However, because the loan is secured by your home, you often qualify for a lower interest rate than other methods.  Keep in mind, though, that this method also means that you are putting your home up as collateral so you could lose your home if you are not diligent about paying the loan back.

401k Loan

Finally, you can take out a loan from your 401k if your plan allows it.  However, there are some negatives to this method.  First, any unpaid balance counts as a distribution which could mean a high tax bill on early distribution if you are under 59 ½ years old.  Second, any money you take out no longer grows and, this being a retirement, account, that could affect your retirement plans.  Finally, if you lose your job or quit for any reason, you may have to pay back the loan immediately.

With all of these options, you will need to weigh the pros and cons.  If the interest rate isn’t lower than your cards and/or the repayment period is longer, it may not be worth it.

Debt Consolidation without a Loan

Credit Counseling Agency

Another option is to go with a credit counseling agency.  They offer nonprofit debt consolidation through a debt management program.  This option doesn’t require you to take out a loan.  An agency will work with your credit card companies to lower your interest rate and monthly payment making it easier for you to pay off your debt.  They also manage the payments.  You send them one monthly payment and they pay the credit card companies.  During this time, most companies will restrict your use of or applying for additional credit.  That can be a good thing, however, if you haven’t started controlling your spending yet.

If you use a credit counseling agency, make sure you make every payment on time.  If you miss a payment or pay late it could cause the interest rate and monthly payment amount to revert to the original amounts.  The credit card companies allow these reductions with the understanding that you will pay on time. 

Credit Card Balance Transfers

If you have a lower amount of debt and a decent credit score, you could apply for a credit card with a generous balance transfer offer and use that to consolidate your credit card debt.  Some cards offer up to 24-months of 0% interest on balance transfers from other cards.  You will pay a small fee up front, usually 3-5%, but then have up to 24 months to pay the balance off.  The money you save in interest, if paid off on time, usually covers and outweighs the amount of the fee.

Lines of Credit

A line of credit is essentially an amount of money that is available to you in loan form for you to take out at any time. Think of it as a loan you can use like a credit card. For example, my company has a line of credit through Kabbage, which specializes in business lines of credit, and I can use this money to help fund my needs anytime I need it for a fee.  I can take out any amount I want up to the limit whether it is just $100 or $5,000.  The fee varies based on the amount and, like any loan, it has a date it must be paid back by.  If you have a line of credit or apply and get approved for one, you could use this to fund your consolidation. You can apply for personal lines of credit at most banks.

How Does Debt Consolidation Affect Your Credit?

If you chose to go through a credit counseling agency, the impact to your credit score should be small.  As long the as you are paying the agency and the agency is paying the credit card companies on time, there shouldn’t be much of an impact at all.  The main impact will be if a lender looks at your credit report and sees that you are in a debt consolidation program then they may not grant you a loan.  Once the program is completed, however, you will most likely see a significant increase on your score.

If you go the loan route, your score may actually increase slightly as soon as you pay off your credit cards with it.  A personal loan is an installment loan so it affects your credit score less than a credit card.  Therefore, getting the high impact credit card balances off your credit report and replacing it with a lower impact personal loan will help.  The amount owed remains the same but a loan has a definite end date for the balance to be paid off rather than a potentially never-ending balance on a credit card.  Further, making the loan payments on time and paying more than the minimum payment can increase your score even faster. 

Should You Consolidate Your Debt?

Debt consolidation is most beneficial for those who are overwhelmed by the number of payments they are having to make each month and have multiple high-interest credit cards.  If you are starting to feel anxiety over your debt or it is affecting your well-being, you should definitely consider consolidating.

We, personally, have consolidated debt twice, in two different ways.  Yes, I wish I had learned my lesson the first time but we were young and didn’t pay attention to our spending or budget which is why I feel so strongly about having one now.  We also had some unforeseen expenses. 

First, as young people with access to credit cards, we went a little overboard and ended up with multiple maxed out cards with high minimum payments.  We felt like we were never going to get our debt paid off.  We went through a credit counseling agency that got our payments and interest rates lowered allowing us to pay off our debt in about 2 years. 

The second time, about 10 years later, we had some additional credit card debt due to some irresponsible spending, some medical bills, unforeseen expenses, etc.  This time, we chose to go the loan route to pay them all off.  The loan has a lower rate than the credit cards and has a fixed payment that allows you to pay it all off within a specified amount of time.  Further, there are no penalties for paying it off early so, if we have it, we can throw extra money at it to pay it off faster.

The loan we got the second time we consolidated was from  It is specifically geared toward taking out a loan to pay off debt.  You will give them the total amount of your debt and choose a time period and, once approved, they will send you the money for you to pay off your cards.  They will then automatically draft your payment each month for the loan.  Rates can vary and may be higher than traditional personal loans but can still be significantly lower than credit cards making it worth it.  Plus, like I said, there is no penalty for paying it off early so you can put everything you have into paying it down.

When is Debt Consolidation Not a Good Option?

Debt consolidation is NOT a good option if you aren’t going to change your spending habits.  There is no point to it if you consolidate and then use all your credit cards again.  You need to create and stick to a budget, track your spending, and pay attention to what you are doing with your money.

It is also not a good option if it won’t reduce your interest rate and payment amount or work out timewise.  You do not want to be stuck paying more money over the long run.  Make sure you do all your research on fees and costs associated with consolidating your debt in order to make an informed decision on whether or not it is worth it.

Disadvantages of Debt Consolidation

While we have spoken of some of the advantages of debt consolidation, realize that there are some downsides as well.  You may have a lower payment but your loan term may end up being longer than if you paid each credit card individually meaning paying more in interest, especially on a personal loan, by the time you pay it off.  This may be worth it if you are really struggling but, if you are not, it is something you want to take into consideration.

Also, you will have only one payment but it will be a high payment.  It will, most likely, be lower than all your minimums combined but you have to remember you are combining all your debt so your payment will be significant.  Make sure you save something from each paycheck to cover the payment each month or pick a payment date that will allow you to pay it with no worry for other bills.  Some companies may let you make payments toward your monthly amount due on a weekly basis so use that option if you can to avoid feeling the pressure of a higher payment.

In the end, weigh your options carefully before deciding to consolidate.  If your balances are relatively low and you can manage the payments, consider finding a way to make some extra money and use a credit card plan like the debt snowball to pay them off.  If, however, you are overwhelmed and have determined that you can get a lower interest rate plus one monthly payment then go for it.  As long as you do your homework beforehand it can be a great option.

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