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Debt Consolidation: Everything You Ever Wanted to Know

From unpaid taxes to credit cards and student loans, consolidation could be the solution you need.

Debt consolidation helps you find financial freedom
If you’re seeking debt relief, whether it’s for student loans or credit card debt, you’ve probably heard of debt consolidation. But unless you’ve faced challenges with debt before, this may be the first time you’ve encountered this concept. If so, this page is designed to teach you everything you need to know about consolidating debt.

Define “consolidate”

Debt consolidation is a financial process where you take multiple debts and combine them into a single monthly payment. In most cases, you can only consolidate debts of the same type. So student loan consolidation occurs separately from credit card consolidation if you have both types of debt to eliminate.

The goals of consolidation may vary based on the type of debt and your financial situation. However, in general, you consolidate to:

  • Simplify your bill payment schedule
  • Reduce your total monthly payments
  • Minimize or eliminate interest charges

Types of Debt Consolidation

Credit card debt consolidation

This type of debt consolidation focuses on credit cards and other unsecured debts. That includes credit cards, store cards, unsecured personal loans, unpaid medical bills and even payday loans.

There are three ways to consolidate credit card debt:

  1. Use a balance transfer credit card for a debt transfer
  2. Take out a personal debt consolidation loan
  3. Enroll in a debt management program through a credit counseling agency

The method you choose depends on how much debt you have, your credit score and how much free cash flow you have available for debt elimination. The goals of credit card consolidation are almost always to (1) reduce your total monthly payments and (2) minimize, suspend or eliminate interest charges applied to your debt.

Student loan debt consolidation

Although student loans are unsecured debt, they usually have to be consolidated separately. In general, you also want to keep different types of student loan debt separate as you consolidate. That means if you have private and federal student loans, you should consolidate them in two different plans.

  • For federal student loans
    • You can consolidate using a Federal Direct Consolidation Loan or an FFEL Consolidation Loan. To use this, you must have at least one loan of either type. For example, you can use a Direct Consolidation Loan if you have at least one original Federal Direct Student Loan. If so, then you can consolidate almost all types of federal student loan debt.
    • You can also use Federal Repayment Plans to combine multiple federal student loans into a single monthly payment. These plan have different goals. Some of them focus on paying off your debt quickly to minimize interest charges. Others lower your monthly payments so it’s easier to avoid default.
  • For private student loans
    • You can consolidate private student loans together with a Private Student Debt Consolidation Loan. Although this type of loan allows you to consolidate private AND federal loan debt, it’s best to keep private separate. Otherwise, the federal loans you consolidate become ineligible for federal repayment plans and loan forgiveness programs. For private student loans, the goal of consolidation is usually to lower interest charges and reduce monthly payments.

Tax debt consolidation

If you have multiple years of back taxes that you owe to the IRS, you can use an Installment Agreement (IA). This combines unpaid taxes from multiple filing years into a single, simplified monthly payment. It does not stop interest or penalties on the money you owe. Installment agreements can run for up to six years. The fixed monthly payment you make depends on how much you owe, in total.

If you owe less than $10,000 you can set up a simple installment agreement on your own through the IRS website. If you owe between $10,000 and $50,000, the process is a little more involved, but you can get approved without special considerations. For more than $50,000, you must provide proof of income and assets to show you can make the monthly payments.

5 Things to Know about Debt Consolidation

#1: DIY usually only works with simple, low-volume debt

Whether you’re talking about credit cards, student loans or tax debt, this tip holds true. Do-it-yourself consolidation is usually the most effective when you have a low volume of debt. If you owe over $50,000 of any type of debt, it’s probably best to get professional help. This is also true if your situation is “complicated.”

For example, let’s say you have several types of federal student loans. You’ve already consolidated some of them with a Direct Consolidation Loan. Now you want to use an income-based repayment program and qualify for Public Service Loan Forgiveness. If all of that sounds complicated, that’s because it is. Going through a federal student loan consolidation company ensures you can execute the plan successfully. They can help you avoid common pitfalls and make adjustments to your plan as needed.

#2: Recognize that consolidation and settlement are different solutions

People often confuse consolidation with debt settlement, but the two are very different. With debt settlement, the goal is to settle your debt for less than the full amount owed. By contrast, the goal of consolidation is to pay back everything you owe.

Consolidation simply makes it easier to manage debt within your budget. You restructure debt repayment so you can make the payments each month without struggling. Although you may reduce interest charges, the principal is always repaid in-full.

#3: When done correctly, consolidation should not damage your credit

This is another way that consolidation and settlement differ. Settling your debts for less than what you owe creates a negative remark in your credit report. This lasts for seven years from the date of balance discharge.

On the other hand, consolidating debt should not negatively affect your credit if you execute your plan correctly. In fact, in most cases consolidation improves your credit score. It creates positive credit history each time you make a payment on time. It also reduces your overall debt burden, which also helps you achieve a higher credit score.

Typically, the only time consolidating debt damages your credit is when you miss a payment or drop out of a consolidation program.

#4: Reconsolidation is usually permitted

Generally if you consolidate debt and your plan doesn’t work out, you can usually reconsolidate with another solution. For instance, let’s say you use a personal debt consolidation to consolidate credit card debt. Then as you repay the loan you run up new balances your credit cards. You begin to struggle to make the payments again. You can reconsolidate using a larger debt consolidation loan or enroll in a debt management program. In both cases, the original consolidation loan can be included in your new plan.

If you use a Federal Direct Consolidation Loan for student loan debt, you can still use federal repayment plans, too. The government even allows you to switch between different repayment plans if your situation changes. In most cases, there’s not even a limit on the number of times you can switch in a single year.

#5: Consolidation is not always guaranteed to lower your payments

Two of the federal repayment plans you can use to consolidate federal student loans can actually increase your payments. Standard repayment is designed to pay off all of your loans in 10 years or less. This allows you to get out of debt quickly, but the tradeoff is you may have higher monthly payments. With graduated repayment, the payments start low but then increase by 7% every two years. As a result, the final payments you make can be even higher than the standard plan.

Even with credit card consolidation, lower payments are not guaranteed. Since this type of consolidation works to reduce or eliminate interest charges, this usually lowers your monthly payments, too. However, depending on how much debt you have and the length of the repayment schedule, the payments may be higher.