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What Is Debt Consolidation?

When you’re stuck in the deep end of credit card debt, student loan payments, car loans and medical bills, it’s hard to keep your head above water. If that’s you, you might be looking for a way out. Maybe you’ve heard about different debt help options—things like debt consolidation, loan balancing, loan refinancing or even debt settlement.

Hey, we get your fears and frustrations (and why you’re looking for a way out). But we want to share the truth about debt consolidation before you head down that road. Most of these schemes are run by companies who claim to offer hope but really just want to profit off your money problems. Listen carefully: There is real hope for you, and it doesn’t start with debt consolidation. Read on to learn why you should avoid consolidation (and other methods) and how you can get out of those dangerous waters of debt for good.

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What Is Debt Consolidation?
Should I Consolidate My Debt?
What Are the Types of Debt Consolidation?
When Is Debt Consolidation a Good Idea?
How Does Debt Consolidation Work?
What Are Alternatives to Debt Consolidation?
What’s the Fastest Way to Get Out of Debt?

What Is Debt Consolidation?

Debt consolidation is the process of combining several debts into one monthly payment in a streamlined payoff plan. Sounds pretty great, right? Don’t get too excited . . . It’s not everything it seems to be.

So, before you decide to consolidate your debt, here are a few things you should know:

  • Debt consolidation offers a lower monthly payment because you’ll have an extended repayment term. Aka—you’ll be in debt longer.
  • A lower interest rate isn’t always a guarantee when you consolidate. (Yup, you could get a higher one. Yikes.)
  • Debt consolidation loans often come with fees for loan set up, balance transfer, closing costs and even annual fees. That means shelling out even more money you don’t have.
  • This one is a big one: Debt consolidation does not mean debt elimination.
  • Debt consolidation is different from debt settlement. (P.S. Both can scam you out of thousands of dollars.) With debt consolidation, you combine your loans into one payment—hopefully with a lower interest rate. With debt settlement, you pay someone else to negotiate smaller payments for you (often unsuccessfully).

Should I Consolidate My Debt?

The answer is always no—unless you’re wanting to consolidate your student loans (and even that’s on a case-by-case basis). Here are five reasons why you should just say no to debt consolidation:

1. When you consolidate your loans, there’s no guarantee your interest rate will be lower.

The lender or creditor will set your new interest rate depending on your past payment behavior and credit score. And even if you qualify for a loan with low interest, there’s no guarantee your rate will stay low.

2. Lower interest rates don’t always stay low.

That low interest rate you get at the beginning is usually just a promotion and only applies for a short period of time. Spoiler alert: That means this rate will eventually go up.

Watch out for “special” low-interest deals before or after the holidays. Some companies know holiday shoppers who don’t stick to a budget tend to overspend and then panic when the bills start coming in. Don’t be a target!

Though this offer is often used to tempt you into a credit card balance transfer, other loan companies will also hook you with a low interest rate, then inflate the interest rate over time, leaving you with even more debt!

3. Consolidating your bills means you’ll be in debt longer.

In almost every case of debt consolidation, those lower payments mean the term of your loan gets dragged out longer than the seasons of Grey’s Anatomy. Extended terms mean extended payments. Not interested, thank you very much. The goal isn’t to extend the length of time you’re making payments—your goal is to get out of debt . . . ASAP!

4. Debt consolidation doesn’t mean debt elimination.

If debt consolidation meant debt elimination, we wouldn’t warn you to stay away. We’d tell you to jump on board! But sadly, debt consolidation really means you’re just moving your debt around—not actually getting rid of it.

5. Your behavior with money doesn’t change.

Most of the time, after someone consolidates their debt, the debt grows right back. Why? Because they don’t have a game plan for sticking to a budget and spending less than they make. In other words, they haven’t established good money habits for staying out of debt and building wealth. Their behavior with money hasn’t changed, so why should they expect their debt status to change too?

Debt consolidation doesn’t fix any problems. It just shuffles them around.

What Are the Types of Debt Consolidation?

Debt consolidation loans are either secured or unsecured. Both are varying degrees of terrifying (kind of like the Scream movies). Here’s why:

If you take out a secured loan to consolidate your debt, you have to put up one of your assets (like your car or your house) as collateral—and that’s a terrible idea. This is basically like leveling up your debt in one of the worst ways possible. Now you’ve got this consolidated loan from a company that can come after your car or your home if you miss payments. No, no, no, no.

If you take out an unsecured loan, you aren’t offering up your stuff as collateral. Great, right? Well, not so much. The loan company knows this is riskier for them, so they charge a higher interest rate to cover their backs.

Now, let’s take a look at the different types of debt consolidation (and why they’re a bad idea):

Debt Consolidation Loan

Like we said, debt consolidation loans can be secured or unsecured, depending on the terms. They come from a bank or a peer-to-peer lender (aka social lending or crowd lending from an individual or group).

Peer-to-peer lending is growing in popularity, but that doesn’t mean it’s a trend to jump on. Those “peers” aren’t doing this out of the goodness of their hearts. They’re running a small business that profits from your financial struggles.

Credit Card Balance Transfer

Credit card balance transfers are another popular form of debt consolidation. This is where you move the debts from all your credit cards to one new one.

First of all, this method usually comes with transfer fees and other various and painful conditions, like a huge spike in the interest rate of the new card if you make a late payment.

Secondly, if you’re thinking of this option so you can work the system and rack up credit card rewards, think again. Those risks we just mentioned are not worth a few airline miles or a couple gift cards to your favorite burger joint.

Finally, if you’re struggling with credit card debt, another credit card won’t solve the problem. It’ll just create a new one.

Home Equity Line of Credit (HELOC)

Some people use a home equity line of credit (better known as a HELOC) as a type of debt consolidation. This secured loan allows you to borrow cash against the current value of your home, using the equity you’ve built up in your home as collateral.

Equity is the difference between what you owe on the house and its market value. So, with a HELOC, you’re basically giving up the portion of your home you actually own and trading it in for more debt so you can pay off your other debts. That right there is a debt trap! And those sneaky financial moves don’t help you . . . they keep you in debt longer and put your house at risk!

Student Loan Consolidation

Last but not least, there’s student loan consolidation. This is the only type of consolidation we would ever recommend—but it’s not the best choice for everyone. It works for federal student loans only and rolls your multiple loans into one lump payment. (If you’ve got private student loans, you could look into refinancing, as long as you follow our recommendations on doing that wisely.)

Type of Debt


What It Is

Should You Do It?

Debt Consolidation Loan

A personal loan that combines multiple debts into one monthly payment

No. These come with an extended payoff date, fees and often higher interest rates. Sometimes you have to put your car or home up as collateral. Gag.

Credit Card Balance Transfer

A new credit card that combines all your other credit card debt into one monthly payment

No. This method comes with fees and a huge spike in interest with any late payments—and it gives you one more credit card to worry about.

Home Equity Line of Credit (HELOC)

A secured loan where you borrow against the equity in your house to pay off your debts

No. You’ll be giving up the portion of your home you actually own and trading it for more debt. Plus, your home becomes collateral and can be taken away. Again—gag.

Student Loan Consolidation

A loan that rolls your federal student loans into one lump payment

Maybe. If you’ve got multiple federal student loans, especially with variable interest rates, consolidating can help you focus on one fixed payment.

When Is Debt Consolidation a Good Idea?

Student loans are the only kind of consolidation we can get behind—and only in particular cases.

The upside of consolidating your student loans is that it narrows down your multiple federal loans into one payment. It can also trade any variable rates you have for a fixed rate—so you don’t have to stress about your interest shooting up suddenly. And if you’ve defaulted on your student loans, consolidation can help you get back in good standing.

But there are also some downsides to student loan consolidation. It usually lengthens your loan term—meaning you’ll have a lower monthly payment, but you’ll also be making more payments in the long run. Plus, consolidation won’t get you a lower overall interest rate, so you won’t save any money on that end.

The best question to ask: Would you rather knock out your student loans one at a time, or focus your energy on one larger loan (with a fixed interest rate)? Whatever you do, don’t just sit back and only make the minimum payment. Attack your student loans with everything you’ve got so you can get them out of your life for good!

Pro tip: Check out our Student Loan Payoff Calculator to see the difference you can make on those student loans if you pay extra on them now or even after consolidation!

How Does Debt Consolidation Work?

When a person consolidates their debt, they get one big loan to cover all their smaller loans. Sounds nice, right? You only have to make one payment instead of several. But that one loan comes with added fees, longer payment periods, and often a higher interest rate!

The process can vary based on what kind of loan you get, but it usually goes something like this:

  1. You fill out an application.
  2. The lender checks your credit and debt-to-income ratio.
  3. You provide a heck of a lot of documentation about your debt, finances, identity, mortgage, and more.
  4. The lender evaluates you.
  5. You do or don’t get the loan. In some cases, the lender pays off your debts and now you’re in debt to that lender. Other times, you get the money or a line of credit to go pay them off yourself—and you’re still in debt to the lender.

Does Debt Consolidation Hurt Your Credit Score?

Does debt consolidation hurt your credit score? Yup. And we aren’t fans of credit scores, but you should know exactly what happens if you consolidate your debt.

The way credit scores are set up, they really want you to keep a debt for the long haul (part of why we don’t like them) and pay on it consistently over time. When you roll over old debts into a new debt, you hurt that consistency in the eyes of “the great” FICO. So, yes, your credit score will suffer if you consolidate your debt.

What’s the Difference Between Debt Consolidation and Debt Settlement?

There’s a huge difference between debt consolidation and debt settlement.

We’ve already covered consolidation loans: a type of loan that rolls several unsecured debts into one single bill. But debt settlement is when you hire a company to negotiate a lump-sum payment with your creditors for less than you owe.

Sounds great right? Someone does the dirty work for you and you get to keep more of your paycheck? Not so fast. These debt settlement companies also charge a fee for their “services,” usually anywhere from 20–25% of your debt! Ouch. Think about it this way: If you owe $50,000, your settlement fees would range from $10,000–12,500.

And if that’s not bad enough, dishonest debt settlement companies often tell customers to pay them directly and stop making payments on their debts. And while you’re putting money into a separate savings or escrow account, your debt settlement company is sitting on their hands, waiting for the right time to negotiate your debt—only after you fork over the fee of course. And sadly, many of these companies don’t even negotiate, leaving you stranded with even more debt.

Most of the time, these companies will just take your money and run—leaving you on the hook for late fees and additional interest payments on debt they promised to help you pay!

Debt settlement is a scam, and any debt relief company that charges you before they actually settle or reduce your debt is in violation of the Federal Trade Commission.1 When it comes to debt settlement—stay away. Period.

What Are Alternatives to Debt Consolidation?

If you’re looking for alternatives to debt consolidation, you’ve come to the right place. The debt snowball method is the absolute best way to pay off your debt. With this alternative to debt consolidation, you aren’t focused on moving around or combining your debts—you’re working on paying them off. Every. Last. One.

Here’s how it works: List your debts smallest to largest (no matter the interest rate). Pay minimum payments on everything but the smallest—you’re going to throw everything you can at this one to pay it off as quickly as possible. (How? Cut back your spending, get on a budgetmake extra money, etc.)

Once that debt is gone, take all the money you were paying toward it and apply it to the second-smallest debt. Keep making minimum payments on the rest.

It’s like a snowball plowing down a hill at top speed—nothing can stop the momentum and nothing can stop you! Keep attacking each debt until every single one is gone.

Yup—gone. Not “settled” or “balanced” (which are two super misleading words when it comes to these debt companies). And definitely not somewhere else with a different interest rate. Gone. 

What’s the Fastest Way to Get Out of Debt?

The fastest way to get out of debt is to get on a plan and stick to it. But before you see any life-change, you’ve got to decide it’s time to change the person in the mirror (that’s you!). If that feels overwhelming, we get it. But life-change starts with one small decision at a time, one day at a time.

It’s definitely not easy, but it’s way easier when you have a plan! Put one foot in front of the other and keep moving. That plan is called Financial Peace University. You’ll walk through nine lessons that show you everything from how to save for emergencies, how to pay off debt, and even how to save for the future. Nearly 10 million people have learned what it takes to win with money . . . and you can too.

Ready to break up with your debt for good? Try Financial Peace University today!

Ramsey Solutions

About the author

Ramsey Solutions

Ramsey Solutions has been committed to helping people regain control of their money, build wealth, grow their leadership skills, and enhance their lives through personal development since 1992. Millions of people have used our financial advice through 22 books (including 12 national bestsellers) published by Ramsey Press, as well as two syndicated radio shows and 10 podcasts, which have over 17 million weekly listeners. Learn More.

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