What is debt consolidation and when do you do it?

Debt is tricky to manage when spread across multiple loans and credit cards with different minimum payments and due dates. And when you can only afford minimum payments, repayment progress can feel slow. One solution that can make the job easier — and sometimes faster — is debt consolidation. It may also provide you with a monthly payment that fits your budget if your minimum payments are no longer affordable.

What is debt consolidation? Simply put, it's when you combine several high-interest debts into one loan with one manageable monthly payment. Debt consolidation isn't the only path to debt relief, but it might be the best option for some financial situations. Understanding the following factors and methods can help you decide if and when consolidation makes sense for you.

Factors to consider before debt consolidation

Debt consolidation doesn't make sense for everyone. You should consider the following factors when deciding if it is a good option for you. And if you do choose to consolidate, it's crucial to avoid accumulating new debt, such as using a zero-balance credit card to make purchases you can't immediately pay off. Additional debt can undo your progress or worsen your financial situation.

Total debt amount

If your debt is manageable, consolidation may make it more so. However, other debt relief options might suit your situation better if your total debt has outgrown your budget.  

Interest rates

Consider how the rates of your current debts compare to what you might get with consolidation. Sometimes, the difference isn't significant enough to make consolidation worthwhile.

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Credit score

A higher credit score can lead to better rates. If your credit score has slipped, consolidating at this time might not save you any money.

Repayment timeline

Consolidation could help you pay off debt faster, but it depends on the new loan's terms. A shorter term means a higher monthly payment, which might not fit within your current budget.

Pros of debt consolidation

There are some clear benefits to consolidating debt that can positively impact your financial situation and even put you on a path to debt-free parenting:

• Streamlined finances: Consolidation offers an excellent benefit: simplicity! You can enjoy the ease of having just one monthly payment to manage instead of juggling multiple minimum payments and due dates.

• Faster debt payoff: Switching to a loan with a lower interest rate allows you more money to go toward the loan principal — the amount borrowed. You'll reduce your debt more quickly, and watching your balance decrease can be a great relief. Just be sure to stick to purchases that fit your budget to avoid falling back into a similar situation! 

• Potential credit score improvement: Paying off debts through consolidation can boost your credit score. Reducing multiple balances to zero improves your credit utilization ratio — the percentage of credit you're using. 

Cons of debt consolidation

Despite the positives, there are a few potential downsides to consolidation:

• Added costs: Debt consolidation usually isn't free. You might encounter loan processing or balance transfer fees. Additionally, if you select a longer repayment term, you could pay more over time, even if the interest rate is lower.

• Risk of missing payments: The consolidation of debt only works if you stick to those monthly payments. If you miss one, your interest rate could jump. Falling behind can erase any progress you've made, so you want to make sure you can afford the consolidated loan payment.

Methods of debt consolidation

Does debt consolidation sound like it might meet your needs? You have a few options.

And parents, you probably hope your kids don't face a similar debt challenge someday. Greenlight® Infinity, the money and safety app for families, is an excellent tool for teaching kids essential money management skills that can help them avoid unmanageable debt later in life.

Balance transfer credit cards

A balance transfer credit card isn't ideal for consolidating all types of debt, but it can be helpful for high-interest credit card debt. Balance transfer cards often offer deals where you can transfer your existing debt without paying interest for a limited term. However, these cards may have balance transfer fees as high as 5% per transfer.

Debt consolidation loans

What is a debt consolidation loan? It's a fixed-interest loan that allows you to pay off multiple debts. Homeowners may use home equity loans to consolidate debt, but you can find personal loans specifically for debt consolidation through banks, credit unions, and online lenders. Many have origination or processing fees to consider.

Debt consolidation programs

If you're struggling with debt payments, a consolidation program might be better than a new loan. These programs, often offered by credit counseling agencies, negotiate with your creditors for lower interest rates and fees and combine your debts into one manageable payment. The downside? You typically can't take on new debt while in these programs.

FAQs about debt consolidation

These are some of the more common questions people have about debt consolidation.

How does debt consolidation work?

When you consolidate debts, you get a new loan to pay off current debts, usually at a lower interest rate. You focus on one monthly payment instead of juggling several.

Does consolidating debt hurt your credit?

You might notice a slight dip in your credit score depending on how you consolidate your debt. However, making on-time payments and improving your debt-to-asset ratio — your existing debts compared to your available assets — can boost your score.

Is debt consolidation a good way to get out of debt?

It can be for some people. If you are ready to follow a payment plan and avoid taking on more debt, it can be an effective way to pay off what you owe faster, for less interest, or both.

Who qualifies for debt consolidation?

You don't need excellent credit to qualify for debt consolidation. Even if your credit is less than perfect, you might qualify for a loan or balance transfer, but a debt management program may better suit your situation.

What you need to know about debt consolidation

We've answered, "What is consolidating debt?" and explored consolidation options. But the most important thing to know is whether it is the right option for you. It sounds like an easy path out of debt, but it's not the best path for everyone.

You might enjoy a lower monthly payment thanks to a reduced interest rate, a longer loan term, or a combination of both. However, this doesn't always mean you'll pay off your debt faster, save on interest, or have a lower monthly financial commitment. So, think about what you hope to achieve by consolidating. Compare options and interest rates, and crunch some numbers to see if debt consolidation can help you get there.

When you're struggling with debt, you may worry about your family's financial future just as you worry about its safety. Greenlight Infinity can provide you with peace of mind on both fronts. It's an app with banking¹ and safety features — like SOS alerts and family location sharing² — rolled into one. Download Greenlight Infinity today.

¹Greenlight is a financial technology company, not a bank. The Greenlight app facilitates banking services through Community Federal Savings Bank (CFSB), Member FDIC.

²Requires mobile data or a WiFi connection, and access to sensory and motion data from cell phone to utilize safety features including family location sharing and driving alerts and reports. Messaging and data rates and other terms may apply.