Is Debt Consolidation Good or Bad? Pros and Cons of Debt Consolidation

By | December 9, 2021

Are you looking to consolidate your debt? Debt consolidation may help you simplify your finances and make it simpler to pay off obligations. However, there are a few things to think about before taking out a new loan.

Suppose you have several different types of loans with varying interest rates. In that case, it may make sense to combine them into one loan with a single monthly payment.

You’ll only need to manage one account rather than multiple accounts each month, which could help reduce stress and improve financial stability over time. On the other hand, if any of these loans have particularly high-interest rates or fees associated with them, consolidating all of those debts into one low-interest loan might not save money in the long run.

Before making any decisions about debt consolidation strategies, take some time to understand how they work so that you can choose what makes sense for your unique situation.

This guide will talk about the pros and cons of consolidating loans so that you can decide whether or not this is the right strategy for you.


What’s Ahead

  1. What is Debt Consolidation and How Does It Work?
  2. Debt Consolidation vs. Debt Settlement
  3. How Debt Consolidation Works
  4. Types of Debt Consolidation Loans
  5. Pros of Debt Consolidation
  6. Cons of Debt Consolidation
  7. When You Should Consolidate Your Debt
  8. Final Thought: Is debt-consolidation good or bad?
Is Debt Consolidation Good or Bad Pros and Cons of Debt Consolidation
Is Debt Consolidation Good or Bad Pros and Cons of Debt Consolidation

What is Debt Consolidation and How Does It Work?

Debt consolidation is a process that combines multiple loans into one new loan.

For example, if you had three different credit card accounts, each with a $1000 balance and an interest rate of 20% (which is on the low end for some cards), your monthly payment would be around $250.

If all of those debts were consolidated into one new loan with a single monthly repayment at, say, 12%, that would result in lower total repayments over time.

This means that instead of making multiple payments to several creditors every month, only one debt consolidation loan repayment is due once per month, which simplifies things considerably.

However, it’s important to note that this process will not reduce how much money you owe overall – only shift where the money goes each month and what it’s used towards, so don’t take out any large loans or go into debt to consolidate other credit card balances.

Debt Consolidation vs. Debt Settlement

Debt consolidation should not be confused with completely different debt settlements.

Debt settlement occurs when you have already missed payments or are about to miss payments, and the creditor agrees to accept less than the full balance that is owed as payment in full.

This option should only be considered a last resort because it can damage your credit score and often has fees associated with it that can add up to a substantial amount of money.

How Debt Consolidation Works

To consolidate debt, you will need to receive approval from the new lender for a line of credit or loan based on how much debt you have, what interest rates are available in the market at the time and your credit score.

The new loan will be used to pay off the balances of all your other loans, which essentially turns them into one new loan with a single interest rate and repayment term.

For example, let’s say you have two different credit cards. The first has an 18% APR and the second has a 14% APR. You decide to consolidate your debt by taking out a new loan with 16%.

This would not be good because you’re now paying more money in interest than before. However, if you had a 30% APR on your original loan, consolidating it would be a good idea because you would save money.

The best way to know if debt consolidation is right for you is to speak with a credit counselor. They can help determine which option is best for your specific situation.

Read More : Credit Card vs. Prepaid Card: How Do You Know Which Card is Right for You?

Types of Debt Consolidation Loans

Here, we will look at the different types of debt consolidation loans available to you.

(1). Debt Consolidation Loan (Personal loan)

A Debt Consolidation Loan (or Personal Loan) is a loan that is used to pay off all of your other loans. This new loan will have a single interest rate and a repayment term. It can consolidate credit card debt, personal loans, student loans, or any other type of debt.

This is the most common type of debt consolidation loan. It’s a personal loan that you can use to pay off your credit card debts, medical bills, student loans, and other types of unsecured debt.

The interest rates for personal loans are usually lower than what you’re currently paying on your credit cards, making it a good option for debt consolidation.

You can use a personal loan to consolidate any debt, including credit card debt, medical bills, student loans, and more.

(2). Home equity loan or line of credit

A home equity loan or line of credit is a loan secured by your house, which you use to consolidate all your debts. This type of debt consolidation loan can assist those who have bad credit and need to take out loans to move financially forward.

Your home serves as collateral, which gives the lender incentive to approve and not penalize you for risk. You should be aware that risks are also associated with this type of debt consolidation.

First, suppose it turns out that you’re unable to pay back the money. In that case, foreclosure proceedings will begin immediately, which will only accelerate the already chaotic state.[1] Second, if your interest rates exceed 16 percent,[2] then this method won’t save much money; after all, we’re consolidating to avoid high-interest rates.

A home equity loan or line of credit can be a good option for debt consolidation if you have bad credit and need to take out a loan. It’s also a good option to consolidate multiple debts into one monthly payment.

(3). Cash-out Mortgage Refinance

What is Cash-out Mortgage Refinance? A cash-out mortgage refinances a refinancing of your mortgage in which you borrow more money than the outstanding balance on your current mortgage. The additional funds are then used to pay off other debts, such as credit cards and student loans.

The advantage of a cash-out mortgage refinance is that you can get a lower interest rate than what you’re currently paying on your debts. This can save you a lot of money in the long run.

However, there are some risks associated with this refinancing. First, if you can’t make the monthly payments on your new mortgage, you could lose your home. Second, if the interest rates rise, you could end up paying more for your mortgage than you did before.

A cash-out mortgage can be a good option for debt consolidation if you’re able to get a lower interest rate than what you’re currently paying on your debts. It can save you money in the long run, but there are some risks associated with it.

Read More : Credit Cards or Debit? Advantages of Credit Cards Over Debit Cards

(4). Student Loan Consolidation

What is Student Loan Consolidation? Student loan consolidation is a process in which you combine all of your student loans into one.

This is usually done by either rolling the loans into a new or existing federal Direct Consolidation Loan or refinancing with a private lender who offers student loan refinance rates that are lower than what you’re currently paying on your other debts.

A student loan consolidation can be a good option for debt consolidation if you want to lower your interest rates and take advantage of federal repayment plans. But it’s not the best choice because there may be origination fees and prepayment penalties involved.

Student loan refinancing is another way many people are consolidating their debts, including student loans. It’s a good option if you want to consolidate and lower your interest rates, but it comes with similar risks as student loan consolidation.

(5). Credit Card Balance Transfer

What is a credit card balance transfer? A credit card balance transfer is the process of transferring your outstanding balances on one or more credit cards to a new credit card. The goal is to get a lower interest rate and save money on interest payments.

You should be aware of several things before you do a credit card balance transfer. First, most Balance Transfer Credit Cards have a fee—usually around three percent of your transfer amount. Second, they usually only offer a 0 percent APR for anywhere from six to 18 months before it becomes variable and much more expensive. Third, if you can’t pay off your balance within that time frame, then you’ll end up paying higher interest rates than what you started in the first place.

A credit card balance transfer can be a good option for debt consolidation if you’re able to get a lower interest rate than what you’re currently paying on your debts. It can save you money in the long run, but there are some risks associated with it.

Pros of Debt Consolidation 

Here are some Pros of Debt Consolidation, which you need to consider.

#1. One monthly payment instead of multiple payments to different creditors.

Your new creditor will pay off your old creditors when consolidating a loan. This means you only have one monthly payment to make instead of multiple payments to different lenders. While this can be advantageous for many people, it may not be the right choice for everyone.

For example, suppose you are consolidating credit cards with a zero percent rate. In that case, the creditor may require keeping your account open for an extended period. If this does not appeal to you, then debt consolidation might not be right for you. 

#2. Easier organization and record keeping.

One consolidated payment schedule can also simplify your monthly financial record keeping. This is because you will have a single document to track rather than multiple documents with payments for different creditors.

#3. It is easier to track expenses and budgets when all debts are combined.

Another benefit of consolidating multiple debts is that it simplifies the payment process. Rather than having to keep track of several different due dates and amounts, you will have one monthly bill for all your loans. This can be helpful for people who have a hard time staying organized or those who want to simplify their financial lives.

For example, suppose you have a budget. In that case, it will be easier to track your spending when your expenses are combined into one monthly payment.

#4. You may be able to get a lower interest rate.

One of the biggest benefits of consolidating your debt is that you may be able to secure a lower interest rate than you were paying before. This could save you hundreds or thousands of dollars in interest charges.

For example, if you have a $20,000 debt with a 20% interest rate, you will pay over $4000 in interest over two years. If you consolidate this debt into a new loan with a 12% interest rate, you will only pay about $1800 in interest.

#5. You can improve your credit score.

Consolidating your debt can also help improve your credit score. This shows lenders that you are taking action to manage and pay off your debts, which is a positive sign.

For example, if you have several maxed-out credit cards, your credit score will likely be lower than if you had no debt at all. 

However, by consolidating your debt into one loan with a lower interest rate, you can improve your credit utilization ratio (the amount of available credit that you are using). This may help boost your credit score over time.

#6. Payoff Might Be Accelerated

Suppose your debt consolidation loan is accruing less interest than your previous debts. In that case, you may be able to pay it off sooner. This is because the money you were sending towards interest each month can now be put directly towards your loan’s principal.

For example:

If you have a $20,000 debt with an interest rate of 20%, and your monthly payment is $400, then you will pay almost $8000 in interest over two years.

However, suppose you consolidate this loan into one with a lower interest rate (e.g., 12%) and make payments of only $333 per month. In that case, you will pay only $3500 in interest over the same period.

Cons of Debt Consolidation

Here are some of the potential drawbacks of consolidating your debt:

#1. You may end up paying more in interest.

If you cannot get a lower interest rate on your new loan, you might pay more money in interest over time. This is because you will be extending the life of your loan and therefore accruing more interest charges.

For example, if you have a $20,000 debt with an interest rate of 20%, and your monthly payment is $400, you will pay almost $8000 in interest over two years.

However, suppose you consolidate this loan into one with a higher interest rate (e.g., 24%) and make only $333 per month. In that case, you will pay more than $11,000 in interest over the same period.

#2. Financial stability may be reduced.

If you are already struggling to make payments on multiple debts, consolidating your debt may not be the best choice. This could reduce how much financial stability you have each month since all of your money will go towards one payment.

If You Have Multiple Credit Cards If your credit card debt is spread out across multiple cards with different due dates, then consolidating this debt into one loan could end up costing you money.

#3. Inefficient use of funds.

Another potential drawback of consolidating your debt is that it may not be the most efficient use of your money. This is because you could end up paying interest charges for a long time instead of using those funds to pay off some or all of what you owe.

#4. You Risk Missing Payments

Suppose you are consolidating multiple credit cards with different due dates. In that case, there is a risk that your payments could overlap. This means that one or more of your payments might not go through if the lender does not receive it in time.

Debt consolidation should be viewed as only one possible solution to debt management. It can help reduce interest charges and simplify your monthly payments, but it is not a cure-all. Before deciding if debt consolidation is right for you, be sure to weigh the pros and cons carefully.

#5. Doesn’t Solve Underlying Financial Issues

Consolidating debt may be easier, but it won’t entirely fix the underlying financial problems that caused you to acquire debt in the first place. You’ll get yourself into a similar scenario if you don’t address these issues.

When You Should Consolidate Your Debt

If you meet any of the following criteria, then debt consolidation may be a good solution for you:

  • You have multiple debts with different interest rates
  • Your monthly payments are more than 30% of your income
  • You’re missing payments or falling behind on your bills
  • Your credit score is below 600
  • You’re planning to make a major purchase (e.g., home or car) soon

Debt consolidation is not for everyone, but it can be beneficial if your current debt situation isn’t ideal. If you want peace of mind and the chance to get out of debt sooner, then this financial strategy might work well for you. Make sure to weigh the pros and cons before making a decision.

Final Thought: Is debt consolidation good or bad?

You may be thinking that consolidating your debt would mean one easy payment and more financial stability. But the truth is, this could hinder how much you can spend on other things each month since all of your money will go towards one monthly payment. So before you consolidate any debts, we recommend seeking a professional to help advise about what might work best for you based on your individual needs and goals.

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Author: Dhiraj Jha

Hi, I am Dhiraj Jha— the founder of a leading personal blog website. I’m an experienced financial expert pursuing my main in personal finance. I have completed my graduation from the Institute of Chartered Accountants of India (ICAI). I always wanted to do something big and better, and today I’m here with my passion for helping people utilize their resources wisely. I love to acquire, review and earn reward points/cashback from credit cards, which help me travel worldwide and stay in luxurious hotels. 

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