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What is Debt Consolidation and How Does it Work?

Debt consolidation is when you bundle several debts together into one larger sum and then make a single monthly repayment instead of multiple smaller ones. Consolidating debts with different interest rates and repayment schedules can make it easier to manage your finances. You can even lower the total amount you have to repay if your debt consolidation method offers a lower interest rate.

There are several ways to consolidate debts. These include transferring all your debt onto just one credit card as well as taking out a secured or unsecured personal loan—perhaps with the help of a professional debt consolidation company.

In this guide, we’ll walk you through your options and show you how debt consolidation could simplify your repayments and save you money.

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Debt Consolidation Guide

Owing money to several creditors and remembering when the monthly payments are due for all of them can be overwhelming. And worse, forgetting to pay on time will lower your credit score and cost you more in late payment fees.

Combining these repayments could make them more manageable and, if in doing so you also receive a lower interest rate, you could end up paying thousands of dollars less in interest overall. If making your repayments by the due date is sometimes a challenge, you may also save money on late fees (that’s if having just one payment per month would increase the chances that you’d pay on time).

You can combine credit card debt, car finance, personal loans, student loans, medical bills, payday loans, and other types of unsecured debt. But is debt consolidation a good idea for you?

To help you decide, we’ll explain how it works, the advantages and drawbacks of debt consolidation, as well as some alternatives you might want to consider.

What is Debt Consolidation?

Although it doesn’t erase what you owe, debt consolidation allows you to pay off your existing debts to your various creditors immediately. Then you begin making a single monthly payment on a new loan agreement that merges all those debts into one.

Ideally, consolidation helps you save money as well as stress. For example, with a credit card balance transfer, you might manage to get a lower interest rate on your newly merged debt.

You can merge what you owe using:

  • Balance transfer credit cards: These often come with 0% interest periods.
  • Debt consolidation loans: You can use your home, vehicle, or another asset to guarantee secured loans for debt consolidation. Unsecured loans are usually harder to get, and they often have higher but still competitive rates of interest.
  • Home equity loans or home equity lines of credit (HELOCs): Home equity loans let you borrow money guaranteed by your home’s equity, generally at a lower rate of interest than a personal loan or credit card. You can often repay these over longer periods of up to 30 years. HELOC loans are similar, except that you can continue to draw money from them—up to a set amount.

How Does Debt Consolidation Work?

Let’s say you have various balances on three credit cards, each with different interest rates, and you pay a fixed amount to each one every month. Table 1 shows what this looks like:

Table 1

DebtBalanceMonthly PaymentDue DateInterest RateTotal InterestPaid Off In
Credit card 1$2,000$1008th16.9%$33424 months
Credit card 2$5,000$25015th22.9%$1,18925 months
Credit card 3$1,000$5022nd28.9%$31827 months

In the example of credit card consolidation in Table 2, paying these debts off with a personal loan would save you $1,102 in interest. You’d also finish paying it off five months sooner and have only one repayment per month to manage instead of three.

Table 2

DebtBalanceMonthly PaymentDue DateInterest RateTotal InterestPaid Off In
Loan$8,000$4001st9.9%$73922 months

The Pros of Debt Consolidation

Repayments are easier to manage

Having a single outgoing monthly debt repayment is much simpler than staying on top of several different ones.

You might pay less interest

You could pay less overall interest with a low-rate loan or a specialist 0% credit card, (interest-free for two years or longer).

Boosting your credit score

If merging your debt helps you make repayments on time, you could see an improvement in your credit rating.

The Cons of Debt Consolidation

Additional fees

You could incur prepayment penalties for settling some debts early. Some credit cards and loans have one-off set-up charges or origination fees to consider, too.

Risk to loan guarantees

If you take out a loan secured on your house or another asset and you don’t keep up repayments on it, the loan provider could seize that collateral.

Paying more overall

Paying over a longer period, even at a lower interest rate, could end up costing you more. Taking out a 0% credit card but not paying it off before the end of the interest-free period will also lead to more interest.

You can read more in our full post here.

Debt Consolidation and Your Credit

Consolidating your debt could mean your credit score goes down initially. That’s because you’re ending several credit agreements at once and replacing them with a new one. Creditors look favorably on stability and a good record of payments made over a long period of time. Applying for new credit and opening new agreements can temporarily make a dent in your credit rating.

But, in the longer term, debt consolidation often improves your credit score. If you’re not missing or making late payments anymore, your creditworthiness will increase. Also, if your credit utilization percentage (the amount of debt you owe vs. how much credit you have available) goes down, your score should increase.

Of course, other factors not directly related to debt consolidation can also affect your scores, such as your credit mix and history. This guide to debt explains more about how debt affects your credit score.

When to Consider Debt Consolidation

Whether debt consolidation is the right solution for you depends a little on each of the following:


Obviously, your take-home pay should comfortably cover whatever your consolidated debt repayment would be, so you can pay it on time every month.


You’ll need to have a good enough credit rating to apply successfully for a 0% balance transfer credit card or a lower interest rate loan.

Current debt

Consolidating is probably worth doing if right now you’re already missing payments or paying high rates of interest that you could decrease by taking out a new agreement.


If you’ve run up debt by spending impulsively, consolidating it won’t solve that issue. It may even give you an opportunity to get into more debt, further hurting your finances and credit score.

Whatever you decide, you should start by examining your finances carefully and calculating whether going through the consolidation process will reduce the total amount you have to pay.

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Steps to consolidate your debt

Here’s a list of concrete actions you can take:

  1. Make a plan: Get the details of your current debts together. Include every creditor you owe money to, when you make payments, how long the agreement periods are, and how much interest you’re paying.
  2. Check credit score: Before making applications for a new loan or balance transfer credit card, access your credit report to check for any errors or problems and to see your credit score. You can get a free credit report each year from the three main credit bureaus—Equifax, Experian, and TransUnion—by going to
  3. Dispute negative items: If you notice any mistakes on your credit report, complain to the relevant credit bureau. How to file a dispute with Experian details a typical process for challenging something on your report.
  4. Improve score: You’ll need a good credit score (of around 670 or higher) to get a loan or credit card with a low enough interest rate. If your score is low, you’ll need to know how to fix a bad credit score before going through the application process.
  5. Find a lender: Thoroughly research personal loan lenders and offers from credit unions. Get quotes to work out how much you could save by consolidating.
  6. Close old accounts: Pay off and close the old accounts immediately once you’ve started the new agreement.

  • Repayment is easier to manage
  • You could save on interest
  • You could boost your credit score
  • Additional fees
  • Risk to loan guarantees
  • Risk of paying more

What alternatives to debt consolidation are available?

If, as things stand, you can pay your debts within 6–12 months and you would save only a small amount with a new loan, consolidating may not be worth it. Making a budget and sticking to it would be a better approach in this situation.

Consolidating also isn’t right if you’re facing overwhelming debt that you have no prospect of repaying in full, even with lower monthly repayments. In this case, you can look to alternative types of debt relief, such as debt settlement or bankruptcy.

Debt settlement

Debt settlement is where you negotiate with your creditors to repay them less than the total amount you owe. Your creditors may agree because receiving some of what you owe is better than getting nothing if you declare bankruptcy.

On the plus side, settlement can give you the chance to pay the debt and stop calls and letters from debt collectors. But it can also have tax implications and is likely to lower your credit score. And initially, you have to find a lump sum of money to make it work.


There are two types of bankruptcy: chapter 7 and chapter 13. Chapter 7 is more common, and it liquidates your assets to repay your creditors. Chapter 13 reorganizes your debt into manageable monthly payments for up to five years. Filing for bankruptcy is a serious step but is the necessary route in certain circumstances.

Debt Consolidation FAQs

What is debt consolidation?

Debt consolidation means merging your debts to pay off several creditors at once using a single, new credit agreement, such as a loan or credit card. Refinancing your debt can reduce the total amount of interest you have to pay, simplify your outgoings, and improve your credit score.

How does debt consolidation affect my credit score?

Taking out a new loan or credit card agreement may temporarily lower your credit score because of the short-term changes on your credit file. But, after a period of six months or so, you should notice an improvement as long as you continue to make repayments on time.

When should you consolidate your debt?

Consolidating is worth considering when you're in a position to make the monthly repayments on the merged debt and reduce the total amount you owe. To reduce the total debt, you need a good enough credit score to be able to refinance at a lower interest rate. You must also be disciplined enough to pay the consolidated debt off until the end of the agreement.

How to get a debt consolidation loan?

There are hundreds of options, so it's important to do your research. You should factor in any set-up fees, loan terms, and the total amount payable over the length of the agreement.

If you'd like to have our take on the best debt consolidation companies, check out our list of the best debt consolidation loans for would-be borrowers in a variety of circumstances. We also cover the options if you have a poor credit score in this comparison of the best loans for people with bad credit

Final Thoughts on Debt Consolidation

To streamline your finances and improve your credit score, replacing high-interest debt through a consolidation process can make a lot of sense. You should investigate it thoroughly before making an informed decision.

Whether you’re thinking about debt consolidation or debt relief, you start by getting all the details together of your current debts. Include how much you owe to each lender, how much interest you’re paying, where the payments fall in the month, and any early repayment fees. Then, compare online lenders’ interest rates, repayment terms, and setup fees to see if consolidating is worthwhile in your situation.

Lastly, think about how and why your debt became expensive and unmanageable in the first place. Be honest with yourself. Consolidation is meant to be a stress-reducer and money-saver. If there’s really no chance you’ll ever be able to pay off everything you owe, it’s not the right move. There are other routes back to financial health that you should consider.


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