At a Glance

In 2020, the total U.S. consumer debt balance grew to $800 billion, an increase of 6% over 2019. Student loan debt, mortgage debt, and personal loan debt increased the most. Credit card debt, which decreased by 9% from 2019, still reached a staggering $73 billion.

That said, the average American has more than $90,000 in debt, from credit cards to personal loans to student loans and mortgages. Debt-to-income ratios, which is your monthly expenses divided by your monthly income, are also sharply rising.

If you’re struggling with debt, you’re not alone. However, there are options to help get you out of debt faster, and even save money in the long-run. Two of these ways are debt consolidation loans or balance transfers.

In this article, you’ll learn more about:

Debt consolidation loan pros and cons

Definition: Debt consolidation is combining multiple debts into one, more manageable payment with lower interest. You do this by taking out one loan to pay off multiple unsecured loans, such as credit cards, auto loans, student loans, and others.

With a debt consolidation loan, the lender will either:

  • Offer direct payment, which means they pay your creditors directly to eliminate your debt. Those accounts would then have a $0 balance and be completely paid off, and you’d then make payments directly to your new lender within 30 days.
  • Deposit the new loan funds into your bank account, and you’ll use that money to repay each of your debts individually and in entirety. You’ll then make your first payment to the new consolidation loan within 30 days.

The goal of debt consolidation is to make managing your debt easier because you’ll only have one payment instead of several. The other goal is that, ideally, your consolidation loan will have a lower interest rate than your other debts so you’ll save money on interest in the long run. This helps you pay off your loans faster and could lower your total payments.

Knowing whether debt consolidation is right for you depends on your end financial goal, but can be a great strategy to lower monthly payments and save on interest. You can also use a debt consolidation calculator to get estimates tailored to you.

Pros

  • If you are making payments to multiple creditors, consolidation makes it so you only have one payment to make each month. That makes it easier to keep track of due dates and payment amounts.
  • Most debt consolidation loans will have lower interest rates than your outstanding debts, such as credit card debt. This can save you money on interest in the long-run.
  • Debt consolidation loans have fixed interest rates and fixed terms, which means your monthly payment will not change and you’ll know exactly when you’ll have your debt paid off.
  • You’re able to pay off multiple kinds of debt with debt consolidation.
  • You don’t have to have excellent credit to apply and be approved. However, this could affect the interest rate you receive.
  • You can likely choose the amount you need, which ensures you have enough to cover all of your outstanding debts.
  • Consolidating your debt may improve your credit score, because when you reduce your credit utilization ratio and the number of accounts with balances on your credit report, your score may increase.

Cons

  • If you have poor credit, you may not be able to get a lower interest rate with a consolidation loan. In this case, you wouldn’t be saving money on interest and the loan may not be right for your situation.
  • Some consolidation loans charge an origination fee, depending on the lender. However, some don’t, so do your research to avoid one.
  • Secured loans have an asset backing it, such as your home or vehicle. For example, a home equity loan can give you the funds you need, but if you aren’t able to repay the loan, you may lose your home or the value could decrease.
  • Debt consolidation doesn’t eliminate your debt, so you still have to budget and watch your spending to avoid taking on more debt.

Balance transfer pros and cons

Definition: A balance transfer means you move an existing high-interest credit card balance to a new, lower-interest card. Or, you use a lower interest card to pay off higher interest rate cards. While this is a type of debt consolidation, it’s primarily useful for credit card debt.

You may even be able to get a card with no annual fee and 0% APR, which means you wouldn’t have to pay any interest at all until the introductory period is over (typically 12-24 months). By doing this, you’re able to save money on interest and pay off your credit card debt faster. Ideally, you can pay off the full balance during that introductory period, avoiding any additional interest.

Pros

  • If you’re able to get a card with a lower interest rate, you’ll save money in the long-run on interest.
  • Instead of paying multiple credit card bills, you’ll be paying only one.
  • Credit cards don’t have repayment terms, so you can make just the minimum payment, or pay as much as you can each month to lower your balance.
  • Could potentially improve your credit score because using the balance transfer to pay off existing credit card debt may lower your credit utilization ratio.

Cons

  • Most balance transfer cards charge a balance transfer fee, often around 3-5% of the transferred balance amount.
  • If you don’t pay off the balance before the introductory rate is over, you’ll end up paying the normal rate on the credit card, which defeats the purpose of saving on interest.
  • Your monthly payment will still fluctuate based on your current balance.
  • There is no guarantee for when your debts will be paid off.
  • Balance transfers are great options for credit card debt, but not as ideal for other types of debt.
  • You may not get approved for a credit limit that’s high enough to pay off your current balances, and you’re not able to choose the limit you need.

Debt consolidation loan or balance transfer?

A debt consolidation loan may be right for you if:

  • You have multiple debts owed to multiple creditors.
  • You aren’t able to make your payments on time each month.
  • Your debts have high interest rates and you want a lower rate to save money.
  • A fixed payment makes budgeting easier.
  • You want to know exactly when you’ll be finished paying off your debt.

On the other hand, consolidating your debt may not be the right option if:

  • You don’t have trouble making your monthly payments on time.
  • You have poor credit and your consolidation loan’s interest isn’t lower than your other debts.
  • You’re close to paying off your debts, or only have one or two small debts.

Balance transfers may work for those who:

  • Have multiple, high-interest rate credit cards.
  • Are able to qualify for a lower interest rate card.
  • Are able to keep credit card balances low.
  • Only have credit card debts, not others (such as auto loan or student loan).

Or, a balance transfer may not be right for your situation if:

  • You have a poor credit score.
  • You don’t qualify for a lower interest rate than the cards you currently have.
  • You plan to continue to use high interest rate cards.
  • You have more than just credit card debt that needs to be consolidated.
  • You aren’t able to afford making the monthly payment after transferring the balance.
  • You have a higher-than-average credit card balance, because the credit limit you’re approved for may not cover it all.

When it comes to paying off debt, the best solution for you depends on your particular situation. The first thing you should do is analyze your debts and goals. Consider what types of debt you have, and if your current credit score will allow you to qualify for lower interest rates. Think about what repayment options and terms work best for your current and future finances.

Ask yourself questions like:

  • What types of debt do I have?
  • What is the total balance of all my debts?
  • How much interest will I pay?
  • What fees do I need to look out for?
  • How will this affect my credit in the short- and long-term?
  • Am I able to make the required monthly payments?

You should also consider why you got into debt in the first place. For example, if your credit card debt is too high because you spend too much on unnecessary items, it’s critical to work on controlling your spending habits; otherwise, you’ll continue to increase your balance that is even more difficult to repay.

Working to create and establish solid financial habits can help you avoid getting into debt again. Create and stick to a budget, use autopay to avoid missing payments, and automatic withdrawal to ensure you pay off your bill and don’t carry a balance.

Finally, it’s important to do your research. Whether you’re consolidating your debts with a loan or looking into a balance transfer, be sure to ask questions and read the fine print to understand exactly what you’re getting into.

Commonly asked questions

Is a balance transfer or debt consolidation bad for my credit score?

Adding another line of credit with a high limit can reduce your credit utilization ratio, which makes up about 30% of your FICO credit score. However, with a lower interest rate, you can pay more each month, which can lower your debt and improve your credit score over time. Also keep in mind that credit history makes up about 15% of your score, so by closing old credit cards, you’re negatively impacting your history.