Pros and Cons of Debt Consolidation: Is It the Right Move for You?

FluxFactory / iStock.com

Commitment to Our Readers

GOBankingRates' editorial team is committed to bringing you unbiased reviews and information. We use data-driven methodologies to evaluate financial products and services - our reviews and ratings are not influenced by advertisers. You can read more about our editorial guidelines and our products and services review methodology.

20 Years
Helping You Live Richer

Reviewed
by Experts

Trusted by
Millions of Readers

Debt consolidation is a commonly used strategy for combining and paying off multiple high-interest balances, usually through a balance transfer credit card, line of credit or personal loan.

The process has drawbacks, however. You could incur fees, see a ding on your credit or exacerbate a bad financial situation. Also, it’s not the best solution if you can’t qualify for a good interest rate or you’re too cash-strapped to manage the new loan properly.

Here’s a closer look at some of the pros and cons of debt consolidation. 

Pros of Debt Consolidation 

• Easier-to-manage debts: Debt consolidation allows you to combine multiple outstanding balances into one monthly payment, eliminating the number of accounts and bills you have to juggle. 
• Lower interest rates: People with good credit can often qualify for a low-interest loan, a favorable line of credit or a credit card with a 0% promotional annual percentage rate (APR), making debt more affordable in the long run.
• Reduced monthly payments: Lower interest rates typically result in lower monthly payments on installment loans. They also slow the growth of credit card balances.
• Faster payoffs, so long as you put the money you’re saving in interest toward your balance and avoid new debts.
• Shored-up delinquent accounts: You can use a debt consolidation loan to pay off collections or past-due accounts, reducing late fees, penalty interest and costly credit report blemishes. 
• Long-term credit score improvements: Getting out of debt and making timely payments on a debt consolidation loan will increase your creditworthiness over time.

Cons of Debt Consolidation 

• Upfront fees or penalties: Some loans carry origination fees or prepayment penalties, while balance transfer credit cards charge to move your debt from one card to another.  
• Extended repayment periods, if you’re converting revolving credit card debt into a long-term installment loan.
• Higher interest costs: Extended repayment periods reduce monthly bills, but usually cost more in interest over the life of the loan. Plus, you might not qualify for a lower interest rate if your credit is subpar.  
• Short-term credit score damage can occur, as debt consolidation may affect your credit utilization, account age, and new credit inquiries — three key factors that contribute to your credit score. 
• The strategy could backfire if you don’t use or repay a debt consolidation loan properly or run up new balances on old accounts. In this scenario, you risk accumulating more debt and further damaging your credit.

Ultimately, the pros and cons of debt consolidation boil down to how you select and manage any new financing. To recap:

Common Debt Consolidation Options 

“Debt consolidation just refers to combining debts under one umbrella at a favorable interest rate,” said Kyle Enright, president of Achieve Lending. “The goal is to pay off debts with higher interest rates, and be left with just one loan at a relatively lower rate.”

The following financial products are commonly used to execute this strategy. 

Personal Loans  

Personal loans are installment loans, meaning you agree to pay your lender a fixed monthly payment over a set period, usually 12 to 60 months. They’re a good option for would-be debt consolidators who want predictable monthly payments and a hard payoff date, provided they can qualify for a low interest rate. Learn more about debt consolidation vs. personal loans.  

Best for: Fixed payments and set terms 

Balance Transfer Credit Cards 

Top balance transfer credit cards let you consolidate credit card debt and buy you time to pay off existing high-interest balances. You transfer them to a new card with a 0% APR, which usually lasts between six and 21 months. This process often entails paying a balance transfer fee of 3% to 5%. 

“You must be able to pay off the transferred balance before the end of the promotional rate,” said Enright. “You also must be careful not to rack up debt on either the old or new card when paying off the balance.”

Best for: People who can pay off debt relatively quickly

Home Equity Loans or HELOCs 

Home equity loans or home equity lines of credit (HELOCs) enable homeowners to borrow against the portion of their home that they own outright. The upside to this financing is that both options tend to carry comparatively low interest rates. The downside is that your home serves as collateral, and you risk losing it if you don’t repay.

Best for: Homeowners with equity 

Debt Management Plans 

For a fee, non-profit credit counselors will negotiate with creditors to set up a debt management plan (DMP). These plans consolidate debts, ideally at a lower interest rate and total balance, into one monthly payment. 

You make this payment to the credit counselor, who disburses the funds as agreed over a set time, usually three to five years. DMPs are a good option if you need help getting out of debt, though they cost you upfront and can damage your credit score.   

Best for: People who need or want help negotiating with creditors 

Will Debt Consolidation Hurt Your Credit? 

Debt consolidation can have positive or negative effects on your credit, and the long-term impact varies, depending on how you manage your accounts.

The negative impacts include:

• The loan application will likely generate a new hard credit inquiry on your credit report and ding your credit score.
• Opening a new account and closing old ones can lower the average age of your credit accounts. Generally speaking, the longer you have credit, the better. 
• Closing credit cards with high credit limits could increase your credit utilization rate, which is how much credit you have vs. how much you’re using. You should keep this rate below at least 30%. 
• Mismanaging your new credit — i.e., failing to make payments, running up a balance — will hurt your credit score in the long term. 

The positive impacts include: 

• Adding an installment loan when you only have revolving credit lines, like a credit card or vice versa, can improve your credit mix and your credit score.
• Paying down high-interest credit card balances with a new loan or 0% APR credit card can lower your credit utilization and increase your credit score.
• Managing your new credit — i.e., making on-time payments and keeping balances low — will improve your credit score in the long term. 

“If payments are consistent and on time, a debt consolidation loan can help improve the consumer’s credit score and overall financial profile over time, which can increase their future borrowing power,” said Leslie H. Tayne, founder of Tayne Law Group, a debt resolution firm.

How To Choose a Debt Consolidation Option 

Take these steps to determine what common debt consolidation option is best for you. 

• Check your credit score to determine the financing and terms for which you qualify. Balance transfer credit cards and personal loans with competitive APRs typically require a good credit score. If your financial profile is spotty, you might need to pursue a DMP, debt relief, or bankruptcy.   
• Compare loan terms, rates and fees. Most lenders advertise APR ranges, repayment periods and upfront fees on their websites, such as Wells Fargo, for example. You can also ask about pre-qualification, where a lender uses a soft credit inquiry — and skips dinging your credit — to provide conditional approval and rate estimates.    
• Assess how much you owe and your ability to repay. Debt consolidation only works if you can make monthly payments and pay off the balance within the allotted time. For instance, you don’t want to select a balance transfer credit card with a six-month introductory APR if you can’t pay off your debts within that window.    
• Consult a lender or credit counselor if you’re unsure. They can provide more insights into your many different options and help you determine which products best fit your financial profile.

Is Debt Consolidation Right for You? 

Debt consolidation is usually a good move if:

• You have many high-interest debts, like credit card balances. 
• You can qualify for rates and terms that make the option cheaper and worthwhile.
• You have a steady income to make new loan payments. 
• You can stop using credit while paying off old balances.
• You want a more straightforward, structured path out of debt. 

Conversely, “taking on more debt will not help someone who’s already having a hard time making even minimum payments, perhaps as a result of a true financial hardship,” said Enright. “In a case like that, they may need to look to debt settlement.”

Share This Article: