Debt consolidation: how it works, when it helps and what to watch for

The short answer: debt consolidation rolls several debts, usually credit cards, into one new loan or plan with a single monthly payment. It saves money only when the new rate and fees are lower and you stop adding new balances.

• Options: a personal loan, balance transfer card, home equity loan, 401(k) loan or debt management plan
• Watch out for: transfer fees (often 3% to 5%) and putting your home up as collateral
• Compare total cost, not just the payment
• After you consolidate: pay off the old debts right away, set up autopay and make a no-new-debt plan
• Next step: Plan it with the Debt Payoff Planner ($6.99).

Debt consolidation means rolling several debts, usually credit cards, into one new loan or plan with a single monthly payment. It can save money when the new interest rate and fees are lower than what you pay today and you stop adding new balances. It doesn't erase debt, and it isn't right for everyone, so this guide explains how it works, your main options, the costs to compare and when another approach makes more sense.

This page is general education, not financial advice. For decisions about your own situation, a nonprofit credit counselor is a good free place to start.

Before you apply for anything, get every balance in one view. Our Debt Payoff Planner lists up to 10 debts, shows your total interest and lets you compare a consolidation offer against your current path.

How debt consolidation works

The basic idea is simple:

1. You take out one new form of credit, such as a personal loan or a balance transfer card.
2. You use it to pay off several older debts.
3. You make one payment each month on the new debt until it's paid off.

The Consumer Financial Protection Bureau points out that consolidation only helps if the new loan or card has a lower rate than your existing debts and you avoid running up new balances on the cards you just paid off. Promotional rates can also end, so you need to know what happens after the intro period.

Main types of debt consolidation

A debt management plan isn't a loan, but it does consolidate payments. Read more in our guide to a debt management plan. For balance transfers, see what a balance transfer is before you apply.

Pros and cons of debt consolidation

Possible benefits:

• One payment and one due date instead of many
• A lower interest rate, which means more of each payment goes to principal
• A fixed payoff date with an installment loan
• Lower credit utilization on your cards, which can help your score over time

Possible drawbacks:

• Fees can wipe out the interest savings
• A longer term can mean a lower payment but more total interest
• A hard inquiry and a new account may cause a small, short-term score dip
• If spending doesn't change, the paid-off cards can fill back up, leaving you with more debt than before

How to compare a debt consolidation offer

Run the numbers before you sign. Here's a simple worksheet you can copy:

If the offer's total cost is lower and the payment fits comfortably in your budget, it is likely a better deal. If the total cost is higher, even with a smaller monthly payment, you'd be paying extra for breathing room. A zero-based budget spreadsheet helps you check that the payment really fits.

Steps to consolidate debt

1. List every debt. Balance, rate, minimum payment and due date for each.
2. Check your credit. Your score shapes the rates you'll be offered. You can get free credit reports at AnnualCreditReport.com.
3. Prequalify where possible. Many lenders offer a soft-check rate quote that doesn't affect your score.
4. Compare total cost, not just the payment. Use the worksheet above. For more on this topic, see our getting out of debt hub.
5. Pay the old debts right away. Confirm each balance shows zero.
6. Set up autopay. Missing a payment can cancel promo rates and add late fees.
7. Make a no-new-debt plan. Decide what you'll do with the paid-off cards, such as keeping them open with a zero balance or locking them away.

Debt consolidation vs. other ways to pay off debt

Consolidation is one tool, not the only one. The FTC's guide to getting out of debt also covers budgeting, talking to creditors and nonprofit credit counseling. You might do better with:

• The debt snowball or avalanche. Pay minimums on everything and send extra to one debt at a time. Compare them in debt snowball vs. avalanche.
• Calling your card issuer. Some lenders will lower a rate or offer a hardship program if you ask.
• A debt management plan. Helpful if your credit score keeps you from getting a good loan rate.

Be cautious with debt settlement companies. They often ask you to stop paying creditors, charge high fees and can seriously harm your credit. The FTC warns against companies that charge fees before they settle any debt.

Signs debt consolidation may not be right for you

• Your monthly spending is still higher than your income.
• The only offers you qualify for have rates as high as your current cards.
• You'd need to put your home up as collateral and aren't confident about the payment.
• You're considering it mainly to free up room on your cards. If home equity is the cheaper path, compare a cash out refinance with a HELOC before you put the house on the line.

If any of these sound familiar, start with a budget and a payoff plan first. Our step-by-step guide on how to get out of debt and our credit card debt payoff plan walk through it. The CFPB's credit card resources are also a helpful, free reference.