Debt consolidation can look like an easy solution if you have multiple loans or credit cards and are struggling to keep up with all their separate payments. But consolidation isn't right for every situation—especially if your goal is to give your credit score a quick boost. So how do you determine when it is worth simplifying your payoff process by taking out a debt consolidation loan? Here are some tips on when it makes sense to consolidate debt, and when it's better to explore other options.
When you should consolidate your debt
You have high-interest debt
Consolidating credit cards or other debt charging over 15% interest can help lower your overall interest costs. Transferring balances to a lower-rate consolidation loan can save you money.
You have too many accounts
Keeping track of multiple loan or credit card payments can be time-consuming and increase the risk of a missed payment. Combining everything into one payment through a debt consolidation loan streamlines the process.
You want a fixed interest rate
Most consolidation loans offer fixed interest rates, which means your monthly payment stays the same over the long term. This makes budgeting easier compared to varying credit card rates.
You need a lower monthly payment
If cash flow is tight each month, a debt consolidation loan can stretch out payments over a longer period, reducing the monthly amount due.
You have good credit
You’ll get the best consolidation loan terms and rates if your credit score is 680+ and you have a solid debt-to-income ratio under 40%.
When not to consolidate your debt
You don’t have a plan to reduce your debt
If you'll continue charging on credit cards after consolidating, it won’t help your situation. Make a plan to change spending habits and get organized to pay off your debts first.
You have very high balances
If you owe more than $50,000 in unsecured debt, consolidation loans likely won’t cover the full amount. Consider other restructuring options, like a debt management plan.
You have poor credit
As noted above, consolidation loans with favorable rates generally require a good credit score. For scores below 620, this method of consolidation may not be possible.
You can’t afford the monthly payment
Make sure the new consolidated payment will fit reasonably within your budget. If not, consolidation could do more harm than good.
You have low credit card rates
I typically recommend paying off high-interest debt first. If your current cards have rates below 8-10%, consolidation probably isn't worth the cost. Focus on paying those down those low rates aggressively before consolidating higher-rate debts.
You can't afford the cost of consolidation
Here's the kicker: Consolidation isn't free. In most cases, you'll need to pay a fee of 3% to 5% of the debt you transfer. Nerd Wallet has a great calculator for figuring out if it's worth the cost in your situation.
The bottom line
In most cases, debt consolidation loans aren't necessary. Think about it like this: Debt consolidation loans are financial products, which means financial institutions wouldn’t offer them to you if they didn’t make money from them.
Still, debt consolidation makes sense if you can save money over the longterm by securing a better interest rate, or if streamlining will be what allows you to make payments on time. The key is making sure this consolidation is part of a larger plan to get out of debt. Consolidating debts into a single loan may simplify things, but it's no solution to underlying financial struggles.