Managing Debt

How to Consolidate Debt

Debt consolidation is the process of combining multiple debts (and bills) into one combined debt. The benefit of consolidating is that it can simplify the debt repayment process and it can help you convert high-interest debts into lower-interest debt.

This article walks you through how to consolidate debt, when it makes sense to consolidate, and some alternatives to consider if you decide it’s not the right debt strategy for you.

How does debt consolidation work?

Debt consolidation works by paying off a number of separate debts – say a few credit cards, a student loan payment, and a personal loan – with one new loan. Some of the types of debt you can consolidate include:

  • Credit cards
  • Unsecured personal loans
  • Payday loans
  • Personal line of credit
  • Medical bills

There are several reasons you might want to consolidate. For one, it can help to simplify the debt repayment process. Rather than keeping track of multiple debts with different terms and various payment due dates, you can just focus on a single repayment. This can lead to fewer late or missed payments which can help you to increase your credit score over the long run.

You might also choose to consolidate if you are carrying a lot of high-interest debt and you can consolidate with a loan that features a lower interest rate. However, whether you can secure a better interest rate will largely depend on your credit score, along with the type of loan you use.

If you're curious about how much you might be eligible to borrow to consolidate your debt, check out loan amount calculator from Discover®.

Ways to consolidate debt

If you are questioning how to consolidate your debt, there are several different strategies you can use, including:

Home equity loan

A home equity loan allows you to borrow against the equity you’ve built in your home. You can use the money from a home equity loan for any number of things – to remodel your kitchen, send your child to college, or consolidate your debt.

Since a home equity loan is a secured loan, you can often get your hands on more money at a lower interest rate than with an unsecured personal loan or credit card. To be considered for a home equity loan which ranges between $35,000 to $300,000, Discover requires a credit score of 620 or higher. Of course, the higher your credit score, the more likely you are to be approved and to get a better rate you may qualify for.

Cash-out refinance

A cash-out refinance is another way you can utilize the equity you’ve built in your home. With a cash-out refinance, you replace your current mortgage with a larger mortgage. The difference between your new mortgage and your current mortgage is the amount of cash you can borrow.

How much money you can borrow with a cash-out refinance depends on how much equity you’ve built in your home. If you’re accepted for a cash-out refinance, the money can be used for nearly any purpose, including debt consolidation. Like the home equity loan, Discover requires a credit score of 620 or higher to consider an applicant for a loan and offers similar terms.

Personal loan

If you don’t have any home equity to tap into, you can consider consolidating with a personal loan. Compared to a home equity loan or a cash-out refinance, a personal loan will usually have a higher interest rate, as a personal loan is unsecured, and it may have a lower range of available loan amounts. If you default on an unsecured loan, the lender has no collateral to repay your debt.

The credit score needed to be considered for a personal loan varies from lender to lender; however, a good to excellent credit score will help you to secure a better rate.

Balance transfer credit card

You can also use a balance transfer credit card to consolidate your debt. Balance transfer credit cards sometimes include a 0% APR offer for a specified period of time, usually between 6 and 18 months.

The goal when using a balance transfer card to consolidate debt is to pay it off before the 0% promotional period ends. To qualify for some of the top balance-transfer credit cards, you will typically need a good to excellent credit score. If you have a low credit score, you might not qualify for a line of credit that gives you enough room to consolidate all of your debts.

When does it make sense to consolidate debt?

There are certain situations when consolidating your debt probably makes sense.

  • You can secure a lower interest rate. If you have high-interest debt, like credit card debt, consolidating at a lower interest rate can help you to save money.
  • You have good to excellent credit. Having good credit can help you qualify for home equity loan or cash-out refinance that features competitive rates.
  • You want to simplify your finances. If you are worried about missing payments or making late payments, consolidating your debt can help to streamline your debt repayment process.
  • You have a plan to pay your debt off. Consolidating your debt only makes sense if you have a plan and the means to pay it off.
  • You have a considerable amount of debt. If you only have a small amount of debt that could be paid off in a short amount of time (a year or less), it might not be worth the fees associated with consolidating.

Debt consolidation makes sense if you can secure better repayment terms and you have a solid debt repayment plan. If you have poor credit and you can’t get a good interest rate or you only have a small amount of debt, debt consolidation might not make sense. Similarly, if you have so much debt that you can’t keep up with your payments, you should consider speaking to your lender or reaching out to a professional for financial help.

Does consolidating debt hurt your credit score?

Consolidating your debt may require a hard inquiry of your credit as you apply for debt consolidation solutions. A hard inquiry can impact your credit score in the short term. However, this initial credit check might be worth it if debt consolidation helps you to pay off your debt faster and at a lower interest rate.

Debt consolidation can also affect your credit utilization rate – this is the total amount of credit you have available to you compared to how much you are using. When you have a $5,000 credit limit and open balances of $4,900, you’ll have a very high credit utilization rate. This signals to lenders you may be overextending yourself. However, if you have a $5,000 limit and only use $500, you may look like someone who can manage their credit and is likely to pay it back.

When you consolidate your debt with a new loan or balance transfer credit card, your credit utilization rate will go down (which is good). This is because you now have more credit available and are using a lower percentage of it. However, if you continue to spend and add up more debt, your credit utilization rate will rise and you risk putting yourself in an even worse financial position than before.

To keep your credit score healthy as you consolidate debt, limit any new credit expenses until you completely pay off your outstanding debts.

Alternatives to debt consolidation

If debt consolidation isn’t the right choice for you, there are other alternatives, including:

  • Create a budget. If you want to get out of debt and stay out of debt, you need a plan for your money. Create a budget and stick to it, limiting any charges to credit.
  • Use a debt repayment strategy. Debt repayments strategies like the debt snowball or debt avalanche can also be good alternatives.

With the debt snowball, you put as much as you can towards paying off your smallest debt first while making the minimum payments on all of your debts. When you bring that smaller debt to zero, you then move those payments towards the larger debts.

With the debt avalanche strategy, you focus on paying off the highest-interest debt first, followed by the second-highest interest debt, and so on, while continuing to make all of your minimum payments.

  • Credit counseling. If you are in a considerable amount of debt and you’re struggling to keep your head above water, reach out to a certified credit counselor. A counselor can review your debts and help you to create a plan forward.

Find out if debt consolidation is right for you

Now that you have a better idea of how to consolidate debt, you can decide if debt consolidation is the right choice. If you own your home, using your home’s equity can be a great way to consolidate your debts, as home equity financing like a home equity loan or cash-out refinance offer better interest rates than credit cards or personal loans and borrowing limits that can wipe out high-interest debt all at once.

To see if a home equity debt consolidation loan is right for you, use our Debt Consolidation Calculator.

And if the numbers make sense, you can visit Discover Home Loans to get a quote on a home equity loan or a refinance.

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