How does debt consolidation work?

Although there are many ways to consolidate debt, it generally works the same way: You pay off one or more debts using a new debt. Some popular debt consolidation methods include personal loans and balance transfer credit cards.

Depending on your unique situation — how much debt you have to consolidate, your credit score, how soon you need the funds, what type of debt you have and other factors — one method may work better for you than another.

→ Personal loans:
Combine many types of debt into one fixed monthly payment with a debt consolidation loan.

→ Balance transfer credit cards:
Consolidate credit card debt onto a balance transfer credit card with a lower APR.

→ Home equity loans:
Tap your home’s equity to pay off debt by using your home as collateral.

→ Debt management plans:
Enroll in a DMP through a certified nonprofit credit counseling agency to repay your debt in three to five years.

Pros Cons
Personal loan for debt consolidation
  • • Fixed APR and monthly payments
  • • Potentially lower APR than what you’re currently paying
  • • APRs can run high for fair and bad credit borrowers
  • • Subject to fees, like loan origination fee and prepayment penalty
  • • Bad credit borrowers may not qualify at all
Balance transfer credit card
  • • Some cards have introductory 0% APR periods, which can last as long as 20 months
  • • Potentially lower APR than what you’re currently paying on your credit cards
  • • Variable APR
  • • Can only be used for consolidating credit card debt
  • • Intro offers reserved for borrowers with strong credit
  • • May be subject to a balance transfer fee of 3% to 5%
Home equity loans
  • • Fixed APR and monthly payments
  • • Interest rates are typically lower than with unsecured debt
  • • Can consolidate a large amount at once
  • • Only homeowners are eligible
  • • You run the risk of going into foreclosure if you fail to pay
  • • You could go underwater on your home, taking out more money than it’s worth
  • • Subject to closing costs
401(k) loan
  • • No credit check needed
  • • Interest rates are low
  • • Borrowing from and paying interest to yourself rather than a lender or bank
  • • Some plans servicers don’t permit 401(k) loans
  • • Payments are made with after-tax dollars, and you’re taxed again during retirement
  • • If you default on the loan, the amount is subject to income tax and a 10% penalty
  • • If you lose employment, you may have to repay the loan in its entirety within a few months
Debt management plan
  • • Comes at low or no cost
  • • A credit counselor may be able to negotiate down fees and interest rates on your debts
  • • Consolidates many types of debts into one monthly payment
  • • Won’t affect credit score if you adhere to the plan
  • • Can only be used for unsecured debts
  • • You’ll likely have to stop using or close your credit cards
  • • Can take up to five years to complete, in which time you can’t take out credit

How to consolidate debt with a personal loan

  1. Check your credit score. Most consolidation options will require a credit check. Unsecured personal loans don’t require collateral, which means that lenders rely more heavily on your credit score, along with other factors, to determine eligibility. Check your credit score for free using My LendingTree.
  2. Calculate how much you need to borrow. Add up all your monthly debt payments that you wish to consolidate. You can use a personal loan to pay off credit cards, payday loans and other high-interest debts.
  3. Determine the APR you need in order to save money. Your APR would need to be lower than what you’re currently paying on your debts for a personal loan to be worthwhile.
  4. Compare APRs by prequalifying with lenders. Many lenders let you prequalify for a personal loan to get an idea of your potential APR without impacting your credit score. This lets you compare estimated loan offers before you formally apply.
  5. Formally apply with a lender. If you’re approved, the lender can deposit the funds directly into your bank account. You can use that money to pay off all types of debt.
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