A guide to debt consolidation

So you have some credit card debt. Maybe a lot of credit card debt. At an average of 20% interest, it’s wickedly expensive to walk around with—maybe it’s already started to feel impossible, if you’re struggling to make payments and feel like you’re just squeaking by without making a dent in the balance.

There are definitely options to manage the frustrating feeling of being pinned under by debt. The simplest, and dare we say most soothing one, is debt consolidation. Here’s a primer on what it is, how it works, and why you’ll sleep better knowing you’re making real progress to living your life debt-free.

What is Debt Consolidation?

Basically, debt consolidation is when you combine several smaller debts or loans into a single loan with one monthly payment.

Technically, you can’t really “combine” all your debts into a single loan since each debt has its own interest rate, so debt consolidation really means taking out a larger loan to cover all the different debts you owe at once. Then you’re only dealing with one payment, and one interest rate. That’s what’s referred to as “consolidating” your debts.

Any unsecured debt that you have – bills, credit cards, lines of credit and personal loans – can usually be included as part of debt consolidation.

What’s the benefit?

First and foremost, it makes your life a lot easier. Instead of having several debt payments to worry about, once you consolidate your debts you’ll only have one monthly payment to make. That means you’re a lot less likely to pay something late because you lost track of it, and you can use your mental energy on things that are way, way more fun.

Consolidating your debt can also save you money by reducing your overall cost of borrowing. If you’re paying credit card interest at 20%, you could likely find a much, much lower rate for a debt consolidation loan. You’d save on interest, and if you kept your payments about the same you’d also reach debt freedom a lot sooner, because more of your money would go towards principal and less is going towards interest.

If cash flow is your issue, consolidating your debts can provide you with some much-needed cushion. You can pay off your debts over a longer period of time by reducing your monthly payment obligations.

The Types of Debt Consolidation

There are several ways to consolidate debt, but most people end up either bundling their debt into an existing mortgage or taking out a personal loan. Here’s the run-down on how those options work.

Adding It to Your Mortgage

If you have enough equity built up in your property, you can roll your debts into your mortgage. You’ll almost always pay a lower interest rate than if you paid each of your debts separately, but it does require heading into the bank to refinance your mortgage, and there may be fees and penalties involved in doing that. Before you refinance your mortgage, you’ll want to know all the costs upfront and crunch the numbers to make sure you’ll come out ahead.

If adding debt to your mortgage makes sense, you have a couple of options. You can add it on top of your mortgage balance or use a home equity line of credit (HELOC) to pay it off, but there are pros and cons to each approach.

Adding your debt to your mortgage usually has the highest interest savings, but you have to make sure you’re ok with the new monthly payments. Since your debts are being added on top of your mortgage, your mortgage payments are going to be higher, and you’ll want to be sure you have the cashflow you handle the bump there.

Use a HELOC (Home Equity Line of Credit)

The second option is to use a HELOC to pay off your debts. Using a HELOC to pay off your debts isn’t likely to result in as big of a cost savings as adding it to your mortgage since HELOC interest rates are almost always higher than mortgage rates; however, you’re still likely to save versus paying off the debts individually. The main benefit of a HELOC is that you can pay it off at your own pace. This makes the most sense when your cash flow is tight, but it can be both a blessing and a curse. If you’re financially disciplined, using a HELOC to pay off your debts can make sense, but if you’re just making interest-only payments, which many HELOCs let you do, you’ll hardly get ahead by doing this. In fact, you could find yourself further behind.

Getting a Personal Loan

Another option is getting a personal loan. The interest rate will almost definitely be higher than adding it to a mortgage, but will definitely be a lot lower than the interest on credit cards and payday loans.

The benefit of a personal loan is that it comes with a repayment schedule that forces you to pay the debt back. That being said, you can usually choose a repayment period that works for you, so your cash flow isn’t too stretched.

Where can you apply for a personal loan to consolidate debt?

Banks, credit unions, and lenders all offer personal loans. The benefit of going through an online lender is that the lending criteria don’t tend to be as strict as a bank or credit union and you can apply online without having to leave your house. If you’ve fallen behind on bills and your credit score isn’t as good as it once was, an alternative lender may be able to find a solution if you’ve been turned down by the banks. At Borrowell, we make personalized loan recommendations based on your credit score and credit profile. Check your credit score and see what you could qualify for.

Other actions for dealing with debt

If debt consolidation isn’t going to work for you, don’t worry. There are still things you can do to pay off your debts sooner.

If you’re struggling with debt and you’ve been turned down for a personal loan due to your credit score, you might consider speaking with a non-profit credit counselor who can help you devise a strategy to get your debts repaid sooner rather than later. You might also consider doing a balance transfer on your credit card if you’re able to obtain a lower interest rate. However, this only makes sense if you’re able to repay a good chunk of your debt before a higher interest rate kicks in.

Rachel is passionate about helping educate others about credit. She’s also a big fan of budgeting and saving - mainly so that she can visit all the places on her bucket list. With its free credit score and report monitoring and automated credit coaching tools, Borrowell empowers consumers to improve their financial well-being and be the hero of their credit.