What is Debt Consolidation, and How Does it Work?

If you’re juggling multiple loans and credit card balances, keeping up with monthly payments might seem impossible. That’s where debt consolidation comes in.

Debt consolidation is a solution that combines multiple debts into one manageable monthly payment. This can be a great way to help you get out of debt, simplify finances and maybe even free up your budget.

Let’s break down what you need to know about debt consolidation to help you take control of your finances and breathe more easily.

What is debt consolidation?

Debt consolidation is a way to pay off multiple debts, typically those with a high interest rate, by combining them into a single, more manageable monthly payment.

How does debt consolidation work?

Here’s how debt consolidation works using a debt consolidation loan. Let’s say your debt from credit cards, installment loans and medical bills totals $9,000. If you take out a debt consolidation loan for that amount, you then use your new loan to pay off those outstanding debts, leaving you with just one loan to manage.

The right debt consolidation loan could potentially reduce the amount of your total monthly payments, giving you more room in your budget and a path out of debt.

It's important to note that debt consolidation is different from debt settlement or credit counseling. A debt settlement agency (DSA) will try to negotiate with your creditors to reduce your balances. A DSA will charge fees for its services and may suggest strategies that can impact your credit.¹ Credit counseling agencies, on the other hand, are generally nonprofits that provide advice on how to manage your debts and may work with you to figure out a payment plan.²

With debt consolidation, you focus on simplifying your monthly payments to more easily pay down debt — sometimes even lowering those payment amounts depending on the interest rate and term.

Types of debt consolidation

You can combine your debt and put a plan in place in a few ways: with a personal loan for debt consolidation, a credit card with a balance transfer offer, or a home equity loan.

Personal loan for debt consolidation

A personal loan is a lump sum of money you can borrow from a lender, bank or credit union and repay in fixed monthly payments, at a fixed interest rate, with a predetermined payoff date. This kind of predictability makes it easier to confidently manage your budget, both now and long term, because unlike a credit card, you know exactly what you’ll pay each month and when the loan will be completely paid off. Another benefit of a debt consolidation loan is the potential for a lower interest rate or lower monthly payments. OneMain offers debt consolidation loans that work with your budget and reduce the stress of multiple bills.

While the debt doesn’t go away when you choose consolidation, you might save money on interest if your new loan interest rate is lower than what you pay now. Check out OneMain’s debt consolidation calculator to get an idea of how much you might save.

Some lenders, banks and credit unions may restrict the types of debt you can consolidate with a personal loan, so be sure to check before you apply.

How to apply

Many lenders will let you see if you prequalify before you apply for a loan. While applying for multiple loans may affect your credit score, checking for prequalified offers will not. Prequalifying gives you a snapshot of what loan amount might be available to you before submitting your full application. If you are interested in a OneMain personal loan for debt consolidation, it takes only a few minutes to see if you’re prequalified.

Choose the offer that works best for you and then submit your application. The lender will typically require you to provide your personal and financial information, such as proof of identity, residence and income. They will also do a hard credit check, which can have a small, temporary impact on your credit score. If your loan application is approved, review the loan documents during the loan closing phase.

How repayment works

Once you’ve signed the loan documents, the funds can be disbursed. Payment times vary by lender. With a OneMain debt consolidation loan, if you have a bank-issued debit card, the money can be deposited to your bank account as soon as one hour after loan signing, or OneMain can give you a paper check.^†

Once the money is available, you or your new lender will send your creditors the funds needed to pay off the debts you're consolidating. Then you’ll start making one monthly payment to the new lender to pay off the debt consolidation loan. Be sure to always make your payments on time and in full to avoid late fees or additional interest, which may slow your progress paying off your debt and erase any savings you might have gained with the debt consolidation loan.

Credit card with a balance transfer option

Some credit cards allow you to transfer your existing high-interest debt from other credit cards or loans to a card with a potentially lower interest rate.

Many credit cards offer a 0% introductory or promotional annual percentage rate (APR) period when you use them for a balance transfer. During the low-APR offer period, which can range from 12 to 21 months or more,³ you can benefit from a low or 0% interest rate on the transferred balance.

But remember that the honeymoon period for your lower interest rate will end. Be sure to have a plan to pay off that transferred balance before the low-APR offer period is over. If you only make the minimum payment each month, you may not pay off all your debt before the non-promotional interest rate kicks in.

How to apply

You’ll apply for a credit card with a balance transfer offer just like you do with any other credit card. You’ll have to qualify based on factors like your credit history and financial information. Many credit cards charge a balance transfer fee, generally around 3-5% of the amount you’re transferring.⁴ You typically can’t apply for a new credit card with a balance transfer offer, if you already have an account with that credit card issuer.⁵ However, you may be able to use an existing credit card for a balance transfer, if you have enough available credit. Ask your card issuer for more details.

If approved for a credit card with a balance transfer offer, you can provide the card issuer with information about the debt you want to consolidate, including the creditors’ names, debt amounts and account numbers. Depending on the issuer, you may use the card to repay the debts yourself, or the credit card issuer will handle the payments once the balance transfer is approved.

How repayment works

You would start repaying your balance to your new card issuer in the same way you would make payments to a conventional credit card, with a minimum payment due each month. Because it’s a credit card, you’ll also be able to make purchases on it, but be cautious about spending unnecessarily and accumulating unwanted and expensive debt. Note that purchases may not be subject to the low promotional APR, so be sure to check the terms of the agreement before using your card to shop. The card’s non-promotional APR will apply once the offer period ends, which could make any remaining balance more expensive to repay, so be sure to check when the promotional APR expires and plan to pay off the transferred balance before that date.

Home equity loan

A home equity loan allows you to borrow funds against your home’s equity — the difference between what you presently owe on your mortgage and the market value of your home. You can use the funds you receive from a home equity loan to pay off your existing debt.

How to apply

You can typically apply for a home equity loan with your existing mortgage provider, or another bank or credit union.

How repayment works

If you’re approved for the loan, you’ll receive the funds in one lump sum payment. You can use the funds to help you pay off your existing high-interest debt and repay the home equity loan in fixed monthly installments.

It's important to note that a home equity loan is a secured loan, meaning your home is considered collateral (something valuable that you possess to back the loan). If you’re unable to make your loan payments, you could lose your collateral — in this case, your home.

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Simplify your finances with debt consolidation

Debt consolidation could be a game-changer if you’re feeling overwhelmed by multiple debts. Combining your loans and credit card balances into a single, manageable payment can simplify your finances and provide a clear path to paying off your debt. However, it’s important to carefully consider the pros and cons to determine if debt consolidation is right for you.

Sources:

1 https://www.bankrate.com/personal-finance/debt/what-is-debt-settlement/
2 https://www.consumerfinance.gov/ask-cfpb/what-is-the-difference-between-credit-counseling-and-debt-settlement-debt-consolidation-or-credit-repair-en-1449/
3 https://www.bankrate.com/credit-cards/zero-interest/zero-percent-intro-apr-guide/#how
4,5 https://www.bankrate.com/credit-cards/balance-transfer/avoid-balance-transfer-card-mistakes/

This article has been updated from its original posting on Sept. 10, 2019. Matt Diehl contributed to this article.