What To Consider When Consolidating Your Debt

Debt consolidation loans are becoming increasingly popular, especially with the rise of online peer-to-peer lending platforms. And while they help a lot of people lower their interest rates and monthly payments, how can you know if a debt consolidation loan is right for you?

When You Should Consider Consolidating Your Debt

It's not always easy to know when debt consolidation is the right strategy. But if one or more of the following apply, you should definitely give it serious consideration.

The new loan will improve your financial situation. You'll need to define what you expect a debt consolidation loan to do. Is it to lower your monthly payment? Reduce your interest rate? Help you get out of debt faster? Improve your credit score? If it will accomplish at least one of those four purposes it's time to give debt consolidation a closer look.

Your credit score is good enough that you can get a lower interest rate than you’re paying now. Your credit score is the main factor determining the interest rate you'll pay on the new loan. If your credit score is good enough, you should be able to get a lower rate on a debt consolidation loan than you're currently paying on your credit cards.

You’re finally ready to get off the revolving debt merry-go-round. There’s a saying, once a Visa, always a Visa. That’s the core of what the term “revolving debt” means. You can pay a credit card down, but it's too easy to run it back up. If you're ready to get off that treadmill, it’s time to consider a debt consolidation loan.

You’re serious about wanting to get out of debt. A debt consolidation loan can help you get completely out of debt–or put you even deeper in it. If you're at a point where you've had enough, and you want to finally get out of debt, a debt consolidation loan can help you do that. But if the main purpose is to consolidate old debt, the entire strategy can do the exact opposite if you aren't committed to avoiding new debt.

Why to Do it and Why Not to Do It

Like most loan types, debt consolidation loans have their own list of pros and cons. Let's take a look at both.


  • Interest rate reduction. If your credit score is good, the interest rate on a debt consolidation loan is usually lower than the average interest rate on the debt you're paying off.
  • Simplifying your life. Life is easier when several monthly payments are replaced with just one. It takes less time, reduces stress, and frees your mind for better purposes.
  • Opportunity to get out of debt. Since they’re open ended, paying off credit cards is difficult. Simply making the minimum payment doesn't do much. Plus, you always have the option to use the card, therefore increasing the balance. However, a debt consolidation loan will fixed rate and term, like a car loan. This enables you to pay off debt in a very specific period of time. You can even circle the debt freedom date on your calendar!
  • Lower monthly payment. While this isn’t always true, a debt consolidation loan often results in a net reduction in your monthly debt payments. That will improve your cash flow immediately.
  • Credit score “bump”. By paying off several loans and replacing it with a single loan, borrowers may see an increase in their credit scores, or not. While having several paid loans is better than several open ones, you are also taking on a new loan. However, as you pay down the debt consolidation loan by making on time payments your credit score will improve. Due to both the timely payments and lower debt levels.


  • You’ll need good credit to get a better interest rate. Lower interest rates are reserved for those with good credit. If you have average or fair credit, it's possible the debt consolidation loan rate will be higher than what you're paying on your credit cards.
  • One large monthly payment. It can be more difficult to manage a single $500 monthly payment than five $100 payments. Smaller payments usually fit better into cash flow than one large payment.
  • The debt consolidation payment may be higher than your credit card payments. This can happen because of the shorter term. The monthly payment on a 36-month debt consolidation loan maybe higher than 2% monthly payment on your credit cards.
  • Loan fees. Debt consolidation loans usually come with origination fees (explained below) that will increase your debt slightly at the beginning.
  • False sense of security. A debt consolidation loan is an excellent strategy to get out of debt. But that doesn't happen immediately. In the short run, you're simply replacing one form of debt with another. That's why it's important not to take on any new debt after you do the consolidation.

What to Look for When Choosing a Debt Consolidation Company

The number of debt consolidation lenders has been expanding dramatically in recent years. The better-known online lenders are increasingly standardizing, so you're likely to see similar loan terms from one lender to another.

But at the same time, the sheer number of lenders is leading to some unique features. You'll need to be aware of what terms fit within the definition of “normal”. Depending on the lender, and the type of loan used, a debt consolidation loan can actually put you in a worse debt situation than you’re in now.

Here are five factors to consider:

Interest Rate

A typical interest rate on debt consolidation loans falls somewhere between 6% on the low end, and 36% on the high end. If you're seeing higher rates, you'll probably want to steer clear of that lender.

But once again, you’ll want to make sure the rate you're paying on your debt consolidation loan is lower than the average rate you're paying on the debts you're paying off. It will make a little sense to replace credit card debt averaging 24% with a debt consolidation loan at 32%.

Loan Fees

These can also vary by lender, and quite substantially at that. Though application fees and document prep fees are rare with debt consolidation loans, origination fees are very common. They’re expressed as a percentage of the loan. For example, a 3% origination fee will result in a $300 charge on a $10,000 loan. Since it’ll be paid up front–out of the new loan proceeds–you’ll receive $9,700, rather than the full $10,000.

Most debt consolidation lenders charge between 1% and 6% of the loan amount, but some go as high as 8%. How much you'll pay will depend on your credit profile.

Loan Term and the Effect on Your Monthly Payment

Most debt consolidation loans fall between 36 months and 60 months. The shorter the loan term, the higher the monthly payment will be. A 36-month loan could make your monthly payment higher than the combined payments on your current debts.

If your main goal is to get out of debt as quickly as possible, this is a good strategy. But if you're trying to lower your monthly payment, you’ll want to go for a 60-month loan instead.

Prepayment Penalty

Very few debt consolidation lenders have this fee anymore. You'll want to avoid any lender that does have it. After all, you don't want the option to pay off your loan early to be restricted.


Most debt consolidation lenders provide unsecured loans. But there may be a few who will ask for collateral. Unless it results in a dramatically lower interest rate, you’ll want to avoid this type of loan. They’re higher risk loans, due to the potential loss of your collateral. And there are plenty of lenders out there who have no collateral requirements.

Loan Dispersal Process

This is something of a soft trap. Some debt consolidation lenders will disperse loan proceeds directly to your current debts. That makes the consolidation process automatic. But others will disperse the proceeds directly to you, trusting that you'll pay off your debts with the money.

If the proceeds go directly to you, you'll need to have the discipline to pay off the intended debts. If you find unrelated purposes for some or all the funds, you may end up even deeper in debt. That will defeat the main purpose of the debt consolidation.

If Consolidating Your Debt Makes Sense For You, Check These Partners Out

One of our favorite partners is Credible, which offers a guarantee of the lowest rate for debt consolidation. If their final rates are beat by any of the other companies below, Credible will give you $200 even if you close your loan with another provider.

Credible also offers student loans and student loan refinancing.

Other Debt Consolidation Partners

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ChooseFI seeks to uncover helpful services that help you be financially resilient. However, we may receive compensation, at no cost to you, from the issuers of some products mentioned in this article, including from CardRatings for our coverage of credit card products. Opinions are the author’s alone, and this content has not been provided by, reviewed, approved or endorsed by any of these entities. See our disclosures for more info.

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