How to Consolidate Debt: 9 Steps to Regain Control

Debt consolidation holds out an attractive promise: You can roll up several credit card balances, outstanding loans, and other debts into one, bigger loan with a single, lower monthly payment. Owing a lower amount every month makes it less of a stretch to pay off your restructured debt. Then going forward, having a single loan makes it easier to manage on-time bill payment. Say goodbye to juggling different interest rates, amounts owed, due dates, etc.; say hello to a single monthly payment.

The reality of how to consolidate debt, though, is more complicated. For one thing, you need to be in pretty good financial shape just to consider this option (even if paying your debts is a struggle). For another, restructuring your debt might actually mean higher total costs due to lengthier repayment terms. And to really make a difference, any debt restructuring should be accompanied by a fundamental reset of your overall spending.

Following the nine steps outlined below can help clarify how to consolidate debt—step by step.

You typically need to have an OK credit score (at least 660), and come in under 50% on your debt-to-income ratio (as in, all your monthly debt payments divided by your gross monthly income).¹ Otherwise, banks usually charge higher interest rates, if they agree to lend to you at all.

If your debt is small and could be paid off in a year with a few extra payments, some lenders say that debt consolidation might not be worthwhile. And if your debt is overwhelmingly large, it might not work either—calling for a more rigorous option, such as a debt relief program or bankruptcy.² In a U.S. News & World Report survey, most respondents who consolidated had debt of $5,000 to $20,000.³

Not all loans are good candidates for consolidation. Debt consolidation works mainly for unsecured debt. In the survey by U.S. News & World Report, respondents said they’d consolidated the following types of debt:

• Credit cards (55.8%)
• Personal loans (23%)
• Student loans (15.8%)
• Medical bills (13.5%)
• Payday loans (8.2%)

It’s not much use to mix in secured debt, such as home mortgages and auto loans, because their interest rates tend to be lower than personal loans.

And student debt often carries lower interest rates than you could get by consolidating it with other types of debt.⁴ That said, multiple student loans can be rolled into one. The U.S. Department of Education has an online federal student loan consolidation application and a calculator to show what your monthly bill would be.⁵

Several rules of thumb apply when analyzing how to consolidate debt.

• Secured vs. Unsecured. You can generally save money on interest charges if you consolidate unsecured debt through a secured loan, such as a “cash-out” mortgage refinancing or a home equity line of credit (HELOC), because they generally have lower interest rates.
• Short term, lower interest. So, you can also generally save money on interest charges by taking out the shortest-term debt consolidation loan whose monthly payment you can afford.
• Long term, higher cost. Because you pay interest over a longer period, longer terms can sometimes push total loan costs higher, not lower, than the debt you were facing at the outset. A published sample of personal loans showed terms ranging from two to seven years.⁶ This gives you a trade-off to consider: Is lowering your monthly expenses by taking out a longer-term debt consolidation loan worth the higher total cost in the long run?

Online calculators are available from lenders to crunch your specific numbers to estimate total costs.⁷

Comparing the alternatives could help determine your final choice. Here are the typical debt consolidation options:

• Personal loans. The most common choice, with interest rates listed in one published sampling as low as 5.99% and as high as 35.99%, depending on your financial profile and other considerations. Origination and other fees also vary in the sample set, from zero to several percentage points.⁸
• Leverage your home. You could refinance your home to get the money to pay your other bills. But even lenders caution that this “might mean paying more in interest overall in the long run.”⁹ Another option is a home equity line of credit (HELOC). In either case, you are literally risking the roof over your head if you don’t make your new payments.
• Transfer credit card balances. If credit card balances are your biggest problem, you could consider a 0% balance transfer card. A balance transfer fee might be required, but some card companies waive that fee to attract business. Card companies may offer a 0% introductory APR for at least 6 months, and 15 months is not uncommon.
• Debt relief service. Debt relief companies help renegotiate your debt for you—but they’re not all above board. The Federal Trade Commission recommends checking with your state attorney general and local consumer protection agency to find a reputable debt relief service.¹⁰

Ask yourself whether there’s more you can do to adjust your spending and pay off your current bills without a consolidation loan, says the Consumer Financial Protection Bureau (CFPB). And check with your creditors directly to see if you can negotiate lower interest payments or longer terms.¹² You might also want to consult a nonprofit counselor on how to consolidate debt, the CFPB says.

And keep in mind that while debt consolidation can improve your credit score in the long term, the immediate impact might be negative. Improvement comes with a better mix of installment and revolving debt and a successful record of making your payments over time.¹³ The potential for a short-term fall includes the simple fact of opening a new account. Be sure your timing isn’t off, considering possible plans for other major steps such as home buying.

This one is pretty self-explanatory. But when you get this far, you might just want to pause to stare at the new light at the end of the tunnel.

Experts warn against lapsing into a false sense of financial wellbeing, thinking that your debt is paid off. It’s not, it’s only restructured. This is the time to begin budgeting your future spending and making a concerted effort to stick to your plan. Otherwise, consolidation could land you in a worse position. You could end up with a big monthly consolidated loan payment plus a growing number of new bills as you continue spending on your credit cards, store cards, and other accounts.