Friday, 22 January 2021

Debt Consolidation 101: What It Is, How It Works and Where to Find Loans

Debt Consolidation 101: What It Is, How It Works and Where to Find Loans
27 Mar

Juggling debts with different payment due dates, amounts and interest rates can be a headache. It can get even worse when you’re tight on money and don’t know when you’ll be debt-free.

Debt consolidation is one way to simplify your finances. By merging multiple credit card bills and loans into one monthly payment with more favorable terms, debt consolidation can help get you out of the red faster and/or make your monthly payments more manageable.

Here’s a look at how debt consolidation works, how it may affect your credit and different ways you may consolidate your debt.

How does debt consolidation work?

Debt consolidation involves taking out a new loan (often a debt consolidation loan) and using it to pay off other unsecured consumer debts, such as credit card bills. The new loan should have more favorable terms, such as a lower APR, to make repaying your debt more affordable or simply easier.

There are several products you may choose from to consolidate your debt:

A debt consolidation loan is a type of personal loan used specifically to roll multiple debts into one. Debt consolidation loans are unsecured, meaning you won’t need to offer collateral to secure the loan. As the lender assumes more risk in lending to you, you will need strong credit to be eligible for the lowest available interest rates.

Terms on debt consolidation loans vary from lender to lender. However, repayment terms of 24 to 60 months or longer are typical. APRs could start as low as 3.49%, depending on your creditworthiness and the lender.

Choose a debt consolidation loan if you …

  • Can qualify for an APR that is overall lower than what you pay on your existing debt
  • Want the flexibility to choose a shorter or longer repayment term
  • Prefer fixed interest rates
  • Are risk-averse and don’t want to secure your loan with collateral

A credit card balance transfer involves combining multiple credit card balances with a single new card with a low interest rate or promotional 0% APR.

Promotional 0% APRs typically last between 12 to 21 months. Be warned, however: Not all promotional offers are the same and reading the fine print is crucial to understanding what you’re in for if you don’t repay your balance before this period ends. If you sign up for a deferred interest promotion, for example, you may have to pay back all the interest that accumulated from the date of your purchases, plus a now hefty APR on your remaining balance.

Credit cards can also charge a balance transfer fee equivalent to 1.5% to 5% of the amount you’re transferring. So, you’ll need to do the math to determine whether this is a good option for you.

Choose a balance transfer credit card if you …

  • Have credit card debt and can avoid taking on more credit card debt as you repay your consolidated balance
  • Can get a lower APR and fewer fees than what you’re currently paying, even after account for balance transfer costs and potential annual fees
  • Are willing to commit to paying off your balance within the promotional period, if there is

A secured personal loan could be a way for you to gain access to lower interest rates than what may be offered to you by credit cards or an unsecured loan. It is backed by assets such as your home or your car, which could be seized by the lender if you end up defaulting on the loan. It’s important to assess the risk involved in losing your assets in case you suddenly lose your job or find yourself unable to make your monthly payments.

Choose a secured personal loan if you …

  • Need to temporarily increase your cash flow
  • Are willing to assume the risk of losing your assets
  • Are able to reliably make payments in full and on time
  • Cannot secure a favorable offer on unsecured debt

A home equity loan is a lump sum payment that represents the difference between the value of your property and how much you owe on it. You could use this amount to pay off your outstanding debts — however, you could also lose your home if you default on your payments.

How much you can borrow depends on a number of factors including your income and credit history, but you’re usually limited by lenders to 85% of the equity you have in your home. You should have at least 20% equity in your home to even qualify for this kind of loan.

While the interest rate on a home equity loan is typically fixed, you may have to pay for the paperwork and administrative fees. These can add up to between 2% and 5% of the entire value of the loan. Some of those expenses could include a home appraisal of up to $400; a title search of up to $100; and application fees, which could run up to $150.

Choose a home equity loan if you …

  • Live in a stable housing market with little risk of your home’s value going down
  • Have at least 20% equity in your home or more
  • Are comfortable with the interest rate and added fees that come with a home equity loan
  • Can make consistent payments in full and on time

A home equity line of credit treats the equity in your home like a credit card. You can draw on it as needed over a set period of time (usually 10 years), but the interest rate is variable, and this option can also incur membership and transaction fees in addition to closing costs. Some of those expenses might include origination fees of up to 1% of the total amount you’re borrowing, appraisal costs of up to $250, and early termination fees of $1,000 or more.

Keep in mind that banks restrict the value of a HELOC to 80% of the equity in your home, and that interest rates can fluctuate monthly, though most states cap them at 18%.

Choose a HELOC if you …

  • Are able to resist the temptation of easy access to cash
  • Have enough equity in your home
  • Can get a favorable interest rate with a lender willing to waive fees
  • Can make consistent payments in full and on time

Another option for covering your debts is to draw from your 401(k) account, if you’ve already got enough saved up. Keep in mind that you may only borrow half the amount you’ve got vested in your plan, up to a maximum of $50,000, and you’ll pay market interest rates on those funds, equivalent to what a conventional lender might charge.

While you could get up to five years to pay back the funds without penalty, you will pay on it twice: once on the amount you withdraw, and again when you withdraw your funds  in retirement. The upside is you won’t have to go through a bank to arrange this loan, or explain why you need it; usually you just have to fill out a form through your employee benefits’ plan administrator.

Choose a 401(k) loan if you …

  • Have met with a financial planner to explore other financial resources and have determined this is the best option for you
  • Need money quickly and for a short period of time
  • Have a credit score that is too low to get a reasonable interest rate on a different type of loan
  • Don’t plan to leave your job while your balance is outstanding

How debt consolidation may help improve your credit score

  • It can help you pay down your debt sooner. A consolidation loan with a fixed term or an expiration date on a promotional period can be a powerful motivator to repaying your old debts sooner. Less debt can increase your credit score, making you more liable to qualify for better loan products later. The amount you owe on your accounts compared to your income determines 30% of your FICO® Score, a type of credit score commonly used by lenders.
  • Thanks to flexible terms, you can build a history of regular, on-time payments. If you’ve struggled with making payments in the past, you could choose a longer repayment term for lower, more manageable monthly payments in the future. Positive payment history is the most significant factor in calculating your FICO Score, at a whopping 35%. Showing a history of payments that are on-time and in full makes you come across as a more reliable borrower.
  • May lower your credit utilization ratio, if you use a loan to do so. The more revolving debt you pay off, the less you’re using from the total amount of revolving credit available to you, which helps lower your credit utilization ratio. This ratio determines 30% of your credit score. Ideally, you should keep your ratio at under 30%.

Where to find debt consolidation loans

You can apply for a debt consolidation loan through a variety of lenders, including banks, credit unions and online lenders. You may explore lenders using our debt consolidation marketplace.

To help you kickstart your search, you can review the below three lenders.

Debt consolidation loan lenders


Learn more

Best Egg

Learn more


Learn more


5.99% to 25.05%

5.99% to 29.99%

6.46% to 35.99%


36 or 60 months

36 or 60 months

36 or 60 months

Borrowing limits

$4,000 to $25,000

$3,000 to $35,000

$1,000 to $50,000

Origination fee

1.00% – 5.00%

0.99% – 5.99%

Up to 8.00%

Minimum credit score requirement




Are there debt consolidation loans for bad credit?

While you can get a debt consolidation loan for bad credit (below 670), as long as you have enough money for the minimum monthly payments, it may not be worth your while. The worse your credit, the higher your interest rate can be and the more you will have to pay, including origination and other fees, to consolidate your debt.

Keep this in mind as you shop for lenders willing to consider factors beyond your credit score such as your job history or education. Some of your best bets could be online lenders who could offer more flexible terms, or credit unions whose interest rates are capped at 18%. Tapping into your home equity or getting a secured loan (see above) are some other options, but keep in mind the risk of losing your assets if you default on your payments.

Is debt consolidation a good idea? How to decide for yourself

Depending on your individual circumstances, such as your monthly income, type of debts, credit score, and willingness to change your spending habits, debt consolidation may or may not be a good idea.

When debt consolidation is a good option …

  • The reasons behind the financial decisions that led you into debt are clear and you’re committed to ensuring it won’t happen again.
  • You’ve met with a credit counselor or financial advisor to put together a realistic budget (or are confident in your ability to do so on your own)
  • All your other options to get out of debt have been researched and explored
  • Committing to the monthly payments and terms of the consolidation loan are achievable
  • You’re saving money compared to what you were paying previously on all your debts

When debt consolidation might not be the right option …

  • Decreasing your expenses might not be possible and you might rack up balances on old credit lines
  • You’d need a secured loan for good interest rates but you’re risk-averse or worry you won’t be able to keep up with payments
  • Savings are negligible or nonexistent after paying the interest rate and associated fees of a debt consolidation loan

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