How Exactly Does Debt Consolidation Work?

Whether you’re drowning in debt or stuck paying high-interest rates, debt consolidation might make a world of difference for you. When you roll your debt into one payment, you no longer have to juggle multiple interest rates or decide which debt to pay first. Nonetheless, there’s no universal approach to debt consolidation. Some get a bank loan to pay off debt, and others use balance transfers. You’ll need to look at your overall cost of debt to decide which technique works best for you.

Let’s take a closer look at how debt consolidation works and the various debt consolidation strategies.

Decide if Debt Consolidation Is the Right Choice for You

Before taking the leap and consolidating your debt, you should ensure that it makes sense for you financially. Debt consolidation doesn’t lower the total principal amount you owe, but it can reduce the interest you pay in the long run. Not only that but rolling your debt into one loan means you’ll only have to make one payment each month, making it easier to stay on top of your finances.

We recommend carefully looking at how much you owe in total, along with the interest rate of each outstanding debt. If you have multiple sources of debt at varying interest rates, you’ll likely benefit from debt consolidation. However, it’s essential to consider any loan origination fees to ensure they don’t negate your long-term savings.

Our software gives you a comprehensive view of your personal finances, making it effortless to view your outstanding debt balances and payment history. Moreover, you can use our convenient debt simulator [ew1] to figure out how to reduce interest[ew2]  costs.

Determine How to Consolidate Your Debt

There’s no one-size-fits-all approach to debt consolidation. Many consumers mistakenly believe that there’s a single way to consolidate debt; but, that’s far from the truth. The most popular ways to consolidate debt include transferring balances, taking out a personal or home equity loan, and signing up for a debt management plan.

We’ll take a closer look at each of these options, so you can decipher which plan of attack is best for you.

Use a Balance Transfer Card

A balance transfer enables you to avoid steep credit card interest rates. However, this method won’t work for installment loans – only credit card debt. Almost all credit card companies allow you to transfer the outstanding balance from one card to another card. Of course, this transfer comes at a cost: roughly 3% of the card’s balance. You’ll save moneyif you transfer the balance to a card with a lower interest rate and if the fee doesn’t outweigh the savings in interest.

If you’re going to take the balance transfer path, you should look for a credit card with a 0% APR introductory period. During the first six or twelve months, you won’t have to pay any interest, and more of your monthly payment will go towards the principal. If your budget allows, it’s an excellent idea to pay off as much as possible during the interest-free period.

Get a Personal Loan

Consumers with various types of debt tend to opt for a personal loan. In a nutshell, this type of loan allows you to pay off all your debt and subsequently make only one debt repayment each month. Personal loans (or “debt consolidation loans”) typically have a fixed interest rate, so you can plan and know exactly how much you’ll need to pay.

Are you thinking of getting a bank loan to pay off debt[ew3] ? Here’s a list of the most popular financial institutions that offer debt consolidation loans:

Take Out a Home Equity Loan

After you build your home equity, you can use it to your advantage and take out a home equity loan to consolidate debt. Lenders won’t give you the entire market value of your home, but you can expect around 80% – 85%. Once you receive the lump sum, you can use it to pay off high-interest debt. It’s essential to remember that a home equity loan doesn’t replace your mortgage. Instead, your house is the collateral in a home equity loan.

Like other forms of debt consolidation, you need to be mindful of the home equity loan’s origination fees and interest rate. Your end goal is to not only simplify your repayments but also pay less interest.   

Look For Debt Management Plans (DMP)

A debt management plan is an excellent way to roll several forms of debt into one monthly payment and cut your interest rate. However, you can’t use a debt management plan for student loans or medical debt. And unlike some of the options we’ve presented, a debt management plan is not a loan. Instead, a debt management plan is a program offered by non-profit agencies. Before you begin a debt repayment plan, your creditors must agree to the terms.

Various organizations offer these debt consolidation plans, and eligibility often varies by state. Below is a list of well-known agencies that offer debt management plans.

Compare Interest Rates

As with any loan, you’ll want to carefully compare interest rates before consolidating your debt. Also, be mindful of application, origination, and late fees. If you’re ever feeling overwhelmed when comparing interest rates, make sure to use our debt simulator. This handy tool helps you figure out how to minimize your interest costs without pulling out a calculator.

Debt Consolidation at a Glance

From a balance transfer to a bank loan to pay off debt, many debt consolidation strategies can help you reduce interest pay down debt quicker. To start on the right foot, use our powerful debt simulator to see how you can minimize interest. Our collection of tools empowers you to pay down debt, form healthy financial habits, and ultimately achieve financial freedom.

 [ew1]Monthly search volume: 60; keyword difficulty: 50

 [ew2]Monthly search volume: 140; keyword difficulty: 37

 [ew3]Monthly search volume: 20; keyword difficulty: 46

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