If you’re wondering whether debt consolidation makes sense for your finances, the answer is a resounding it depends. Debt consolidation could allow you to combine your debts into one and save money. But factors such as your credit score and financial habits can influence whether consolidating debt will work for you.
To help you decide if debt consolidation is a good idea, here’s what you need to know about the process, its pros and cons, and steps to consider if the numbers just don’t add up.
[Read: Best Debt Consolidation Loans.]
What Does Debt Consolidation Mean?
When you consolidate debt, you pay off multiple debts, like credit cards or loans, by combining their balances into a new, single debt. After consolidation, you’ll have one monthly payment — ideally, at a lower interest rate — that can simplify your finances, save on interest costs and potentially speed up your debt payoff timeline.
For instance, say you have two credit cards with interest rates above 20% and a personal loan with a rate of 13%. If you consolidate those debts into a new loan with an 8% interest rate, you’ll save on interest costs and could pay off your debt faster.
Pros and Cons of Debt Consolidation
It’s possible to consolidate debt in several ways, including with balance transfer credit cards, debt consolidation loans, home equity loans and home equity lines of credit. Depending on your situation and which product you use, you could encounter the following pros and cons.
Pros
1. Simplicity. If juggling multiple payments each month is overwhelming or confusing, debt consolidation could be a good idea to streamline all debts into a single monthly payment.
2. Could unlock a lower interest rate. If you have debts with high annual percentage rates, consolidating could translate to serious savings if you qualify for a new loan or credit line with a lower rate.
3. Possible to get a lower monthly payment. Depending on your credit, you may be able to consolidate debt to get a monthly payment that is lower than your current combined debt payments.
4. Could help you get out of debt faster. If you’re ready to put your debt in the rearview mirror, consolidating could mean a monthly payment or interest rate that helps accelerate your debt payoff by months or years.
Cons
1. Available credit can be tempting. If you use a debt consolidation loan to pay off multiple credit cards, for example, the temptation to use your newly available credit could be strong enough that you’ll keep adding to your debt instead of paying it down. “If you’re going to consolidate your debt, you need to make getting out of debt a priority,” says Jay Zigmont, a certified financial planner and founder of Childfree Wealth.
2. Promotional balance transfer offers can be risky. “The challenge with debt consolidation is that you may feel like you are making progress, but all you have done is move your debt,” Zigmont says. That’s why credit cards with 0% introductory APRs on balance transfers can be a trap if you’re not mindful of how you use them. If you keep rolling the same balance from card to card when the promotional period ends, it’s easy to get caught and start accruing interest — and at a high rate — once again. “You can only shuffle credit cards so many times before you will mess up,” Zigmont says.
3. You could pay more in interest. If you use a personal loan with a longer term to consolidate debt, it could cost you. Even if you get a low monthly payment, a longer repayment term could mean you’ll pay more in interest over the life of the loan than you would have with your original debt.
4. A higher payment could strain your finances. A personal loan with a higher payment than your current debt payments could help you crush your debt faster. But it’s best to make sure that the higher payment doesn’t leave you unprepared for life’s curveballs, such as a medical emergency, layoff or other unexpected expense.
[Read: Best Balance Transfer Credit Cards.]
How to Decide if Debt Consolidation Makes Sense
While debt consolidation can help some borrowers save money, not all borrowers will benefit. A bit of research can help you decide if the products and terms you qualify for will help you save. Follow these steps before you consolidate.
1. Evaluate Your Debt and Set Goals
To start, list all your current debts, including creditor names, account balances, monthly payments and interest rates. Next, separate the accounts you want to consolidate and set your debt consolidation goals. Here are a few goals to consider:
— If you have high-interest debt, you may want to reduce your interest rate.
— If you want to pay down your debt faster, you may want a shorter repayment term.
— If you want to save on overall borrowing costs and pay down debt faster, you may want a lower interest rate and a shorter repayment term.
— If you want a lower monthly payment, you may want to find a longer repayment term.
— If you want the convenience of one monthly payment, you’ll want to make sure you can get a loan or credit line that can cover your current debts.
This exercise can help you determine the loan amount, credit limit or interest rate you’ll need. It can also help ensure that you only pursue options that align with your goals.
2. Assess Your Financial Behaviors
It’s impossible to determine if debt consolidation fits your finances if you don’t understand the financial decisions contributing to your debt. “You have to ask what got you to your current debt position and if you have a strategy to manage the debt you have,” says Werner Loots, executive vice president of consumer lending product at U.S. Bank.
Debt consolidation can leave you open to future mistakes if you’re unwilling to change how you manage debt.
3. Check Your Credit Score
You get a few benefits by checking your credit score before you start shopping for a new loan or credit card. First, you can easily see if something doesn’t look right with your score and rectify potential errors on your credit report before you apply for that loan or card.
You can also use your score to decide if now is the right time to consolidate. Say you’ve been putting more charges on your credit cards in the past year because of a family medical emergency. As a result, your FICO credit score dropped out of the good range of 670 to 739 because your credit utilization is higher. In this situation, you may decide to pay down some of your debt to raise your score before you pursue debt consolidation. That way, you can potentially qualify for better rates and terms a few months down the line.
4. Use Preapprovals to Test the Market
No matter your score, Loots says you can get an idea of the debt consolidation offers you might get — without negatively impacting your credit.
Credit card issuers, banks and other lenders may show you the rates and terms you might qualify for with a short application and only a soft credit pull. When lenders use a soft pull, it doesn’t ding your credit score. While quoted rates and terms aren’t a guarantee for approval, Loots says they’re still helpful.
For instance, if you have multiple credit cards with interest rates over 22%, but are only offered personal loans at 25% interest, it could signal that debt consolidation might not make sense.
[Read: Best Home Equity Loans.]
Is Debt Consolidation a Good Idea?
After following the steps above, it’s time to decide whether consolidating your debt makes sense. The easiest way to do this is to compare the costs of your potential new debt to your current debt. If the products and terms you found help you save time, money or frustration, you might decide to consolidate your debt. However, Loots says it’s possible that the math doesn’t work out in your favor.
“Debt consolidation is best suited to those who can service their existing debt,” he says. “The better your credit, the more and better options you’ll have to consolidate at a better rate.”
If the math doesn’t make sense, Loots says you can still take proactive measures to save.
“Managing your current credit profile is the best preparation for debt consolidation,” Loots says. Too often, borrowers wait until their credit is suffering to explore consolidation options. So if your credit could use a boost, he suggests making moves now.
To improve your credit score, make payments on time and bring delinquent accounts current. If possible, consider switching to cash payments to avoid increasing your credit card debt. You can also explore a service like Experian Boost to give your score a lift. The free service could raise your score by giving you credit for bills that aren’t typically tracked by credit bureaus, including streaming services and rent payments.
When your score improves, you can revisit debt consolidation to see if you qualify for better offers.
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Is Debt Consolidation a Good Idea? originally appeared on usnews.com
