What is Debt Consolidation, and Why is it Helpful?

Most households have debt in one form or another, from student and auto loans to credit cards. The average credit card debt is $6,198, while the average credit card interest rate is more than 16%. A high debt load and high annual percentage rates often create a cycle of debt payments people can’t escape. 

What is debt consolidation, and why is it helpful? If you’re dealing with multiple bills with different interest rates, amounts, and due dates, knowing the answer can help you weigh the benefits and drawbacks.

What is Debt Consolidation?

Debt consolidation is the processing of rolling multiple debts into a single, larger debt, usually with a lower interest rate, smaller monthly payment, or both. Debt consolidation can help with student loans, credit card debt, and other debts.

Consolidating your debt may be a good idea if you have:

  • A Lot of Debt. If you can continue making payments and pay off your debt within a year, debt consolidation is likely not worth the fees and credit checks needed.
  • Raised Your Credit Score. You could qualify for lower rates if your credit score improved since taking out your other loans. 
  • Consistent Cash Flow. While your overall monthly payments may go down, consolidation is not a good option if you can’t cover your current monthly debt.

What Options Are Available for Debt Consolidation?

The two primary types of debt consolidation loans are secured and unsecured. The best option depends on your circumstances, credit score, and the amount of money you need to borrow. 

With a secured loan, you need collateral. You could use your house or car as collateral. But if you fall behind on payments, the lender can take the collateral to satisfy your unpaid balance. 

An asset isn’t needed for an unsecured loan. But these loans are more challenging to obtain and tend to have higher interest rates and lower qualifying amounts.

Debt consolidation options include a:

  • Personal Loan. One of the most common ways to consolidate debt is through a secured personal loan. Obtained through a bank or credit union, debt consolidation loans have fixed interest rates and repayment terms. The duration of the loan and your credit score determine the interest rate. Once approved, you use the loan to pay off existing debts and begin making payments on the new loan. 
  • Credit Card. You may decide to consolidate multiple credit card payments on a new card. Many credit cards provide offers of 0% APR on balance transfers. While you may be subject to balance transfer fees, during the initial period, typically 12-18 months, you don’t accrue interest, making it a good option. 
  • HELOC or Second Mortgage. If your home has appreciated or you paid down a portion of the mortgage, you can use the equity to consolidate your debts. A HELOC often has a lower interest rate than other types of loans, and the interest may be tax deductible. 
  • Student Loan Programs. You can consolidate student loans through federal or private programs. Federal consolidation combines multiple student loans into one. The new loan won’t lower your interest rate, but it will simplify payments. Private student loan consolidation is through a bank or credit union. These loans can lower your interest rate. 

How Can Debt Consolidation Help? 

If you’re committed to paying down debt, consolidation offers certain advantages. We’ll walk you through the benefits to help you decide whether it’s the right way to pay off your loans. 

Advantages of debt consolidation include:

  • Pay Debt Quicker. Making minimum payments stretches your repayment timeline. If your debt consolidation accrues less interest, you can use the extra cash to pay down debt earlier. 
  • Saves You Money. Interest rates add hundreds, even thousands, to your debt. If your credit score has gone up, you may be able to decrease your interest rate and save money.
  • Simplifies Payments. It’s easier to manage debt if you only have to make one payment per month. It reduces your chances of missing payments and can help you budget better. 

Let’s look at debt consolidation and why it’s helpful with an example. Let’s say you have multiple credit cards with various interest rates and monthly payments:

  • Credit Card One: $4,500, 25.00% APR
  • Credit Card Two: $3,500, 19.00% APR
  • Credit Card Three: $2,000, 12.00% APR

You consolidate balances into a single loan for $10,000 with an 8.49% APR. You budget to pay off the loan in four years. With the loan, you pay $1,828.92 in total interest. By comparison, if you made a 4% monthly minimum payment on each card, it would take more than $7,397 in interest payments and nearly 14 years to ultimately pay off the debt.

How Can FFCU Help with Debt Consolidation?

Debt consolidation can be a way to reset your finances. You might be able to pay off debt balances sooner and save money. But it’s necessary to remember that, while it can provide a boost for many, it may not be your best long-term solution. 

Before consolidating, review your balances, interest rates, and credit score. Run the math and consult an expert. If you’re able to pay off your debt within 12 months, consider other payoff strategies, like the snowball or avalanche approach. Contact Focus Federal for help understanding debt consolidation and why it’s helpful or to consolidate your debt.