How does debt consolidation work, and is it worth it? We compare debt consolidation options and provide pros and cons to help you choose.

How Does Debt Consolidation Work, and Is It Worth It?

By Anna Wolf

If you’re feeling overwhelmed by debt, you might be searching for ways to reduce your monthly payments and/or pay everything off sooner. Consolidating debt can be a good solution, but how does debt consolidation work—and how do you know if it’s a good solution for you?

There are a few different ways to consolidate debt, and considerations to be aware of for each. We’ll explore the various debt consolidation options and weigh the pros and cons to help you decide what’s right for you.

 

How Does Debt Consolidation Work?

Debt consolidation generally means using one loan, credit card or service to pay off multiple loans, which can include revolving debt like credit cards or installment debt like personal loans. Instead of making payments to multiple creditors each month, you’ll make one payment to one entity. Debt consolidation can potentially lower your interest rate, reduce your monthly payment and/or shorten the time it takes to pay off your debt.

 

The most common debt consolidation options include:

Debt consolidation loan

An installment loan allows you to consolidate multiple types of debt, including credit cards, medical bills and other types of loans. Installment loans have a set payoff date and let you make monthly or biweekly payments. It may be possible to lower your overall interest rate or reduce monthly payments when you consolidate debt with an installment loan.

 

Benefits and considerations:

  • Most types of debt, including credit cards and loans, are eligible
  • Fixed payoff date, predictable monthly payments and removal of temptation to continue taking on more debt
  • End creditor calls and bring past-due accounts current
  • Possibly reduce monthly payments (usually accomplished by extending repayment term, which may end up costing you more in total interest)
  • Can help you build credit with on-time payments (another bonus: RISE gives you access to your credit score, credit alerts, and tools to help you develop better money habits).

 

Balance transfer

If you only want to consolidate credit card debt, you may be able transfer current credit card balances to just one card. This is often accomplished using a new card with a low introductory interest rate, with the intention of paying off the balance before the intro period ends and the interest rate increases.

 

Potential benefits and considerations:

  • Typically, only credit card debt is eligible
  • New credit card may create temptation to continue charging
  • End creditor calls and bring past-due accounts current
  • Possibly reduce monthly payments by lowering overall interest rate
  • Possibly lower overall interest rate and save money on total interest
  • May initially decrease credit score if debt-to-income ratio (the amount you owe vs. your credit limit) changes drastically, but over time can help you build credit with on-time payments

 

Debt management plan

Also known as a DMP, these plans are offered by credit counseling agencies as part of a program that includes personal finance education. Instead of giving you a new loan, the agency negotiates lower payments with your creditors on your behalf. You make one regular payment to the agency, and they turn around and pay your creditors. In most cases, the creditors will terminate the accounts in question so you won’t be able to charge more.

 

Potential benefits and considerations:

  • Many types of debt, including credit cards and loans, are eligible (student loans and mortgages are not typically eligible)
  • Fixed payoff date, predictable monthly payments and removal of temptation to continue taking on more debt
  • End creditor calls and bring past-due accounts current
  • Learn how to manage your debt better in the future

 

How do debt consolidation loans work?

Debt consolidation loans are a common way to take control of debt. Here’s how they work:

After you’re approved for the loan, the lender will either pay off your existing debts for you or disburse money to you in order to pay off debtors yourself. After that, you’ll only have the one loan to worry about.

When deciding whether a debt consolidation loan is right for you, the math is crucial. Balances, interest rates, fees and maturity dates all play big roles in determining if a debt consolidation loan will bolster your financial wellness. Check out a debt consolidation calculator to research different scenarios.

 

Pros & Cons of Debt Consolidation Loans

Like all financial decisions, there are pros and cons to debt consolidation.

The potential advantages include:

  • Fewer bills: Consolidating your debt into one payment helps you maintain a singular focus. “It is much easier to stay organized. Along with this, you no longer have to decide who should get paid first and how much you should send each creditor,” says Chris Bibey at Money Crashers.
  • Lower payments: High payments often mean missed payments when you are struggling with debt. Bringing down the monthly figure can make your loans more manageable, and increase the chances that you’ll make each payment on time and in full.
  • Lower interest rate: Save money—potentially a big chunk—by paying less in interest each month.
  • Shorter time horizon: If you’re committed to wiping the slate clean, a debt consolidation loan can help you get there faster if you choose a shorter maturity date.

However, debt consolidation loans aren’t a cure-all for financial ailments. Potential drawbacks include:

  • Continuing the debt cycle: “Most of the time, after someone consolidates their debt, the debt grows back,” writes Dave Ramsey. If you don’t address—and improve—your money habits, you could end up right back where you started: struggling with debt. That’s why RISE offers the education and tools to help you take control of your finances.
  • Paying more over the long term: Dave also notes the importance of understanding the time horizon of your debt consolidation loan. Your debt consolidation loan may lower your interest rate and monthly payments, but may also extend the time horizon over which you’ll be making payments. In this scenario, it’s entirely possible that you could end up paying more in interest over the life of the debt consolidation loan than you would have originally.

Whether your goal is to lower monthly payments, pay off debt sooner, rebuild your credit or get creditors off your back (or all of the above), a debt consolidation loan can be a good way to accomplish these goals. And you could consolidate debt as soon as tomorrow with a RISE online installment loan.

With RISE, you borrow what you need, when you need it. With rates that can go down over time and free access to your credit score,* we help you take control of your debt. Apply for an online installment loan with RISE today.

 

* Customers in good standing may qualify for a reduction in annual percentage rate ("APR"). Installment Loan Customers:  In order to be eligible, you must continue to meet RISE's credit criteria, and we will evaluate the stability of your personal information and identity for each new loan.  If eligibility requirements are met and you make 24 successful, on-time monthly payments (48 bi-weekly payments), the APR for your next loan will be 50% off your original loan's APR (excluding customers with starting rates of less than 75%). Additionally, if you continue to meet eligibility requirements and you make 36 successful, on-time monthly payments (72 bi-weekly payments), you will qualify for a 36% APR for your next loan.  Note that it may take two or more loans to reach 36% APR. (In Mississippi, if you make 24 monthly payments (48 bi-weekly payments), the monthly handling for your next loan will be 50% off (excluding customers with starting rates of less than 75%). And, if you make 36 monthly payments (72 bi-weekly payments), you qualify for a monthly handling charge of 3% for your next loan with RISE. Note that it may take two or more loans to reach a 3% monthly handling charge.)   Line of Credit Customers: In order to be eligible, you must continue to meet RISE's credit criteria, and we will evaluate the stability of your personal information and identity.  If eligibility requirements are met and you make 24 successful, on-time monthly payments (48 bi-weekly payments), the APR on your line of credit will be reduced to 50% off your original APR. Additionally, if you continue to meet eligibility requirements and you make 36 successful, on-time monthly payments (72 bi-weekly payments), you will qualify for a 36% APR on your line of credit.  

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