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If you’re making debt payments every month, but it feels like you’re getting nowhere fast, it may be time to consolidate your debt. You may have heard the term “consolidation” but unless you’ve used one of these solutions before, you may not understand exactly how it works. This guide is designed to teach you everything you need to know about debt consolidation. If you still have questions, feel free to head over to our Ask the Expert section to ask our panel of experts.

What is debt consolidation?

The goal is to pay back everything you owe more efficiently.
Debt consolidation refers to any debt relief option that rolls debts of the same type into a single monthly payment. The goal of consolidation is to pay back everything you owe more efficiently. This helps minimize damage to your credit score, which often makes this a more desirable solution versus debt settlement.

It sounds too good to be true, it’s not. Consolidation rolls similar debts into one monthly payment that is typically less than you paid before. This works for credit card bills, student loans, and even back taxes. If you do it right, you won’t hurt your credit score, either.

So, how do you do it right? Debt.com will show you how to consolidate your debt by yourself, or how to consult a professional who can walk you through it. Even if you go your own way, it doesn’t hurt to consult a certified credit counselor for free debt analysis.

You can also learn about other options like a debt management program or debt settlement. But first, find out if debt consolidation is right for you.

Consolidating debt focuses your money on paying off principal.
In most cases, consolidating debt also allows you to reduce or eliminate interest charges. As a result, you can get out of debt faster because you focus your money on paying principal, or the actual debt you owe.

Benefits of debt consolidation

  • You pay back everything you owe more efficiently.
  • You minimize or completely avoid credit damage that can be caused during debt repayment.
  • It simplifies your bill payment schedule with just one bill.
  • With most consolidation solutions, you also reduce or eliminate interest charges.
  • This can make debt repayment faster, even though you may pay less each month.

Types of debt you can consolidate

In general, you can only consolidate similar types of debt. While you can consolidate credit cards and student loans, you usually have to keep them separate. If you owe multiple types of debt, you may need more than one debt consolidation plan.

Type of ConsolidationDebts that can be included
Unsecured debt consolidation (commonly called “credit card debt consolidation” or “credit consolidation”
  • Credit cards
  • Store cards
  • Gas cards
  • Charge cards
  • Unsecured personal loans, including personal debt consolidation loans
  • Unpaid medical bills
  • Collection accounts
  • Payday loans
Federal student loan debt consolidationMost federal student loans, not including PLUS loans to parents
Private student loan debt consolidation
  • Federal student loans
  • Private student loans
Installment agreement (IA)IRS tax debt from multiple years of back taxes on income tax returns
Auto loan consolidationAuto loans on different vehicles

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How does debt consolidation work?

There are 2 ways to consolidate

There are two different ways to consolidate debt. The best way to consolidate debt depends on your unique financial situation.

  1. New financing: Apply for new financing and use the new credit line to pay off your existing debts.
  2. Debt consolidation program: Arrange a repayment plan that pays off your existing debts, but you still owe the original creditors.

How debt consolidation works with new financing

The most common form of consolidation that uses new financing is a debt consolidation loan. However, there are also other versions, such as a Home Equity Line of Credit (HELOC) or balance transfer credit card. Here are the steps involved.

  1. You apply for a loan or credit line that’s large enough to pay off all the debts you wish to repay.
  2. You get approved based on your credit score; approval requirements vary by lender and the type of consolidation loan that you want.
  3. You choose a term for the loan that offers monthly payments you can afford.
    1. A shorter term means higher monthly payments, but lower total costs
    2. A longer term decreases the monthly payments but increases total costs
  4. Once approved, you use the funds you receive to pay off your existing debts.
  5. This leaves only the consolidation loan to repay.

How debt consolidation works using a consolidation program

This type of debt consolidation does not replace old debt with new financing. Instead, you still owe the original creditor. It’s a structured debt repayment plan.

  1. First, determine what monthly payment you can afford on your budget.
  2. Then, structure a repayment plan that uses that monthly payment amount to repay all debts included in the plan.
  3. Interest charges still apply during repayment, but they may be reduced or eliminated; setting up a repayment plan generally stops penalties from being applied.
  4. You make fixed payments according to the agreed schedule until your debt is paid off.

Again, the specifics tend to vary based on what type of debt you owe. Consolidation programs are most commonly seen with tax debt and credit cards.

Credit card debt consolidation

There are four ways to consolidate credit card debt, and only three of them are generally advisable.

  1. Credit card balance transfer
  2. A personal debt consolidation loan
  3. Home equity loan / HELOC / cash-out refinance
  4. Debt consolidation program

Looking for the best way to consolidate credit card debt? Let Debt.com connect you with a top-rated certified consumer credit counseling service to get the answers you need.

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Student loan debt consolidation

There are only two ways to consolidate student loan debt:

  1. A federal debt consolidation loan can only be used to consolidate federal student loan debt.
  2. On the other hand, private debt consolidation loans can be used to consolidate both private student loan debt and federal student loan debt.

Tax debt consolidation

There are two basic ways to consolidate tax debt:

  1. Set up an Installment Agreement (IA) with the IRS
  2. Include it in a personal debt consolidation loan
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Specialized types of debt consolidation

Payday loan debt consolidation

It is possible to consolidate payday loans, but it’s usually limited to using a debt consolidation program.

Military debt consolidation

Military Service Members and Veterans have a special option for debt consolidation called a Military Debt Consolidation Loan (MDCL). They also usually qualify for discounted fees when they enroll in a debt consolidation program.

Using a Military Debt Consolidation Loan (MDCL)

If you purchased your home using a VA home loan, you are eligible to get an MDCL. It’s a loan that borrows against the equity in your home. The MDCL is a cash-out refinance mortgage that pays off your original loan and then gives you the cash difference in equity. So, if your home is worth $120,000 and you owe $80,000 on your original VA home loan, the MDCL gives you a loan for $120,000. You get the $40,000 difference back and can use the funds to pay off debt.

The issue here is still that you borrow against your home’s equity, so you take on an increased risk of foreclosure with an MDCL. In many cases, you are better off using a debt consolidation program, particularly given that military Service Members and Veterans qualify discounted fees on debt management programs.

Medical debt consolidation

It’s also possible to consolidate unpaid medical bills using a debt consolidation loan or debt consolidation program. If you had out-of-pocket medical expenses that were not paid by insurance, these bills can quickly turn into collections. Medical debt collections are the number one cause of bankruptcy in the U.S.

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Debt consolidation questions

Q:
Can you consolidate other types of debt?

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A:

Besides the specialized types of debt, you can also use consolidation for “public” debts. This includes things like back child support, unpaid alimony and court fines.

Q:
Does debt consolidation affect your credit?

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A:

Usually debt consolidation affects your credit in a positive way as long as all the payments are made on time. When done correctly, consolidation should not have any negative effects on your credit. Successfully completing a debt consolidation plan should improve your credit score. You pay off your debt, always making payments on time, which improves your credit utilization ratio while building a positive payment history.

Q:
Does debt consolidation work?

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This depends on your financial situation. As long as you can comfortably afford the consolidated debt payments, consolidation should work. Of course, if your financial situation changes and you can’t afford the payments, then you may run into trouble. Also, you also need to avoid self-sabotage after you consolidate: often, accounts are left open, and you need the willpower to avoid making new charges after that.

Q:
Is debt consolidation a good idea?

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Again, this depends on your finances. If you can barely afford the consolidated debt payment and still struggle to make ends meet, consolidation can be bad. You’ll still end up juggling bills and taking on debt to cover emergency expenses. Consolidation is a good idea when the monthly payments fit your budget.

Q:
Is debt consolidation worth it?

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Determining if debt consolidation is worth it requires that you assess total cost. Basically, you need to look at the total cost of getting out of debt. This includes fees to set up your consolidation plan, as well as interest charges applied during debt elimination.

Q:
When should I consolidate my debt?

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There are two main reason why you want to consolidate debt:

  1. Individual debt payments are taking up too much income and you want to lower your monthly payments through debt consolidation.
  2. You want to reduce the total cost of repaying your debt by reducing applied interest charges.

In many cases, with both debt consolidation loans and consolidation programs, your total monthly payments are reduced. With reduced or eliminated interest charges, you can get out of debt even though you often pay significantly less each month.

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Article last modified on June 4, 2019. Published by Debt.com, LLC