How to consolidate debt

If you have a significant amount of debt with multiple creditors, the idea of paying it off might feel overwhelming. But there are several paths that you can take to streamline the process, and even save money long-term. Here's what you need to know.

What is debt consolidation?

Debt consolidation is the process of combining multiple debt accounts into a single debt with a new annual percentage rate (APR) and repayment term. For example, if you’re carrying $10,000 in credit card debt across several cards, you could use a credit card consolidation loan to pay off those cards. While you still have the debt, it’s now consolidated into a single loan, ideally with a lower rate and monthly payment. That said, there are many ways to consolidate debt, and the best option will depend on your circumstances.

Learn more: What is debt consolidation?

Compare debt consolidation loan rates

What are the best ways to consolidate debt?

Here are a few options for consolidating debt, and how they work:

Personal loans for debt consolidation

Personal loans are offered by banks, credit unions, and online lenders. They typically come with lower interest rates than high-interest debt like credit cards — the average APR on a two-year personal loan was 12.35% in November 2023, according to the most recent data from the Federal Reserve, while the average APR on credit cards was 21.47%.

Repayment terms range from one to seven years, depending on the lender. And along with the APR you qualify for, the repayment term you choose plays a significant role in determining your monthly payment. In short, a longer repayment period generally means you’ll have a lower monthly payment, but pay more overall in interest. A shorter term, meanwhile, means you’ll likely have a higher monthly payment, but pay less toward interest.

One great thing about consolidating debt with a personal loan is how quickly they can fund. If approved for a personal loan, you could have your debts consolidated within days of applying. Some lenders even offer loan funds the same day you apply. You may also be able to get a rate discount for debt consolidation if you instruct the lender to remit funds directly to your creditors.

Learn more:

• How to use a personal loan to pay off debt
• Average personal loan interest rates

Balance transfer credit cards

These often have a 0% APR introductory offer that lasts at least six months. In exchange for paying a balance transfer fee (generally, 3% to 5% of the transferred amount), you can avoid interest for the duration of the promotional period. Since promotional periods aren’t as long as the repayment terms of other forms of debt consolidation, monthly payments may need to be much higher in order to pay off the amount transferred within the 0% APR period.

Home equity loans

If you own a home that’s accumulated equity, you may have the option to borrow against that equity to pay off some or all of your other debts. Lenders generally prefer that you maintain at least 20% equity in your home, considering all loans against it. In other words, if you have a home worth $500,000, and a $300,000 mortgage, you may not be able to borrow more than $100,000 via a home equity loan ($400,000 is 80% of the home’s value). Once approved, you can generally use the loan funds as you see fit.

Home equity loans can last from five to 30 years, which can help lower monthly payments, but could increase the amount you’ll pay toward interest substantially if you opt for a longer term.

However, rates tend to be lower relative to unsecured loans, like personal loans, which makes it crucial to compare rates, terms, and total interest payments on all types of loans you’re considering.

You should be prepared to go through a longer application and approval process with a home equity loan. Unlike personal loans, they can take a month or more to close.

Retirement loans

If you have money in a 401(k), 403(b) or 457(b) retirement account, you may have the option to take out some of those funds in the form of a loan. These are limited to half of your vested account balance, up to $50,000, and typically come with a five-year repayment requirement.

A 401(k) loan or other type of retirement loan is generally not advised since one could set your retirement savings back years. Plus, they can have severe tax consequences if mishandled, or if you leave your job during the repayment period. However, they may be an option if you need a loan and have bad credit, since there’s no credit requirement as you’re borrowing from your own account.

How to apply for a debt consolidation loan

Before you apply, it’s vital to shop debt consolidation lenders and prequalify with more than one to find the best rates and terms. Prequalifying can help you understand if you’re likely to qualify, and if so, what your personal loan terms may look like. Plus, it won’t impact your credit. (But keep in mind, it’s not a promise of your actual rates and terms.)

From there, you can often apply with your preferred lender online, at which point the lender will conduct a hard credit pull that could ding your score by a few points for up to a year. In addition to personal information like your Social Security number and income, you’ll be asked about the debts you want to consolidate, including account numbers, and how much money you want the debt consolidation lender to pay out to each account (if the lender is paying your creditors directly). Once approved, your debts could be paid off within days. And you would begin making payments on the new loan.

Can you consolidate debt with bad credit?

It is possible to consolidate debt with bad credit — but you may not be able to access the best rates and terms, and you may need to apply with a cosigner or with a co-borrower to get your loan approved. A cosigner is responsible for loan payments if you don’t make them, but has no access to the loan funds, while a co-borrower shares responsibility for the loan and has equal access to the funds. Both co-borrowers and cosigners — and you — will likely see their score drop if you miss payments or default, so make sure you can comfortably afford the payments. Some lenders also offer secured personal loans, which can be easier to be approved for.

Lenders that consider applicants with bad credit

Alternatives to debt consolidation

If you aren’t able to qualify for traditional debt consolidation options, you may consider opting for something like a debt management plan (DMP).

Debt management plan

Reach out to a credit counseling agency for debt management options. If you go this route, a credit counselor may be able to negotiate on your behalf with creditors to lower your payments, remove fees, or reduce your rates. The plan may have some monthly fees, and you’ll generally need to close the accounts in the DMP (which could damage your credit). But you’ll hopefully be able to get a more manageable monthly payment, and can work toward building up your credit with on-time payments.

Debt settlement

Debt settlement is another route that sometimes gets confused for a DMP, but it’s very different, and generally not advised. Debt settlement typically requires you to pay fees to a company that negotiates with your creditors to reduce your debt, lower the amounts owed, or change the terms to make it more affordable. But you may be required to stop making payments as a negotiation tactic, which could severely damage your credit and even open you up to legal action by your creditors, and there’s no guarantee the approach will work or that negotiations will be successful. Another potential downside here is that any forgiven amount may be taxable as income.

Negotiate directly with creditors

You can also call your creditors and try to negotiate directly with them for free, without having to go through another party. If you have a good relationship with your creditor, you may be able to get them to enroll you in a hardship program, which may temporarily lower or pause your payments. If no hardship programs are offered, you could still attempt to get fees waived, lower your interest rate, or reduce your balances.

Bankruptcy as a last resort

If you can’t see yourself being able to afford any payments, or have dug yourself too deep into debt, perhaps due to medical bills or runaway credit card interest, bankruptcy may be your best option.

Consult with a credit counselor first, to see if there are other options. If not, find a bankruptcy attorney to see whether you’re eligible for Chapter 7 or Chapter 13, and which makes the most sense for your goals and situation.

In either case, bankruptcy will have major negative effects on your credit — your score could drop 100 points or more, depending on what your score is when you file — and can stay on your history for up to 10 years for Chapter 7 and seven years for Chapter 13.

How to consolidate debt FAQ

How do debt consolidation loans work?

When you get a debt consolidation loan, the funds are used to pay off your existing debts. From there, you’d make payments to your new lender until the debt is paid off. You may also have to pay fees, like origination fees, depending on the lender.

Learn more: How does debt consolidation work?

What is debt relief compared to debt consolidation?

Debt consolidation is often a credit-dependent tool that combines multiple debts into a new single loan with its own rates and terms. With debt relief, on the other hand, a private company attempts to get some of your debts forgiven or have the terms changed. (This is also called debt settlement.) There is no guarantee of success, however, and it can have a major negative impact on your credit.

Does debt consolidation hurt your credit?

Opening a new line of credit may cause a small drop in your credit score — usually no more than five points, and usually for only up to a year. But if you’re able to make your monthly payments and you use debt consolidation to lower or eliminate your current balances, you should see an increase in your score in the long term.

Related articles: 

• Best personal loans
• Best personal loan rates
• Where can I get a personal loan?
• Do personal loans affect your credit score?
• How to get out of debt with bad credit
• Ways to consolidate credit card debt
• Types of debt consolidation loans