The Pros and Cons of Debt Consolidation

Monthly payments. Due dates. Late fees. Debt can feel overwhelming – and it can be hard to keep up.

If you’re struggling with multiple bills, debt consolidation may be a sensible option to consider. Also known as bill consolidation, a debt consolidation loan allows you to take multiple debts and combine them into one loan with a fixed monthly payment.

Is it smart to consolidate debt? It depends on your circumstances. We’ve rounded up some pros and cons of debt consolidation to help you figure out if it could be right for you.

Pros of debt consolidation

• You’ll make just one payment each month
  Multiple due dates can be tricky to manage. Debt consolidation allows you to pay off several bills at once. So instead of juggling multiple bills and due dates, you’ll have just one to manage.

• Fixed payments allow you to budget
  With a fixed interest rate, a debt consolidation loan features a monthly payment amount and due date that remains the same as you pay off the loan as scheduled. This consistency can make budgeting easier.

• You know when you'll finish paying off your debt
  Unlike credit cards, a debt consolidation loan has an end date. Since it’s an installment loan, the debt will be paid in full when you make your last monthly payment. As long as you continue to make your monthly payments on time, the debt will be paid in full by the scheduled end date.

• You can save money with a lower interest rate
  The interest rate you get on a debt consolidation loan may be lower than the rate you’re paying on your existing balances, which can free up cash in your budget for other things you need.

• You may not need to put any collateral at risk
  Some types of loans, such as home equity loans or vehicle title loans, require collateral. This means that your home or vehicle is used to guarantee that you’ll pay the loan back. Unfortunately, if you default on a secured loan, the lender has the legal right to seize the collateral used to secure the loan to recover the outstanding balance. If you qualify for and choose an unsecured debt consolidation loan, no collateral is needed.

• It can help build your credit
  If managed correctly, a debt consolidation loan can actually help build your credit. For example, just as paying credit cards and other bills on time boosts your credit score, paying a debt consolidation loan on time may strengthen your credit score. By paying on time for the length of your loan, you can also increase your positive credit history, which can further increase your score.

The cons of debt consolidation loans

• Potential for higher interest rates
  Lower interest rates aren’t guaranteed, so be sure to compare the fixed interest rate on a debt consolidation loan to all the rates on your existing debts.

• It may take longer to pay back your debt
  Many people opt for debt consolidation as a way to help them lower monthly expenses. However, it’s important to note that a new loan may have a longer repayment term than your existing debt, so while you may pay less per month now, with the new loan, the total of all payments you make may end up being more. So, take time to investigate how long it will take to pay back the new loan and its full cost at the end of the term.

• Fees and closing costs
  Lenders may also charge origination fees, which will add to your total loan amount, as well as application, prepayment and late fees. Take time to read the fine print and ask potential lenders about upfront and future fees.

• A new loan may not solve underlying financial issues
  If you consolidate your existing debts, but continue to overuse your credit cards, the new loan won’t put an end to your problem. You also need to make a budget and change any spending behaviors that contribute to your debt.

When should you consider debt consolidation?

A debt consolidation loan might be a good fit if you:

• Have a hard time making monthly payments on time.
• Are unable to pay balances down quickly, as the majority of your current payments go toward interest and are not reducing your existing principal balance.
• Feel overwhelmed by debt and aren't sure how to get out of it.

A chance to simplify your finances

Debt consolidation can be a great way to provide you with breathing room while you simplify your finances. Like all financial decisions, be sure to ask questions and do your research to make sure you’re dealing with a credible lender. Take time to weigh the pros and cons of debt consolidation, and you’ll know if it’s the right decision for you.