Short answer: a debt consolidation loan replaces several debts with one loan and one payment. It saves money only if the new loan's APR, fees and term together cost less than what you pay now. With bad credit the rate offered may not be low enough, and the CFPB warns that fees and a longer term can make consolidation cost more overall (CFPB).
Three ways people consolidate
| Option | How it works | Main risk (CFPB) |
|---|---|---|
| Balance transfer card | Move card balances to one card with a low or 0% promotional rate | The promotional rate ends and the rate can rise a lot; there is usually a transfer fee |
| Debt consolidation loan | A bank, credit union or other lender pays off your debts and you repay one installment loan | Origination fees, and a longer term that lowers the payment but raises the total cost |
| Home equity loan | Borrow against your home to pay off other debt | If you do not repay, you could lose your home in foreclosure |
Source: CFPB.
The math on $6,000 of card debt
Assumptions: $6,000 of credit card debt at 28% APR, paid off in 36 equal payments if you keep it on the cards. Consolidation loan at 20% APR, no other new borrowing. Your rates may be higher or lower.
| Plan | Monthly payment | Total interest and fees |
|---|---|---|
| Keep the cards, 28% APR, 36 months | $248.18 | $2,934.53 |
| Consolidation loan, 20% APR, 36 months, no fee | $222.98 | $2,027.33 |
| Same loan with a 5% fee added to the balance | $234.13 | $2,428.70 |
| Consolidation loan, 20% APR, stretched to 60 months | $158.96 | $3,537.80 |
The lower rate saves money over the same 36 months, and a 5% fee eats part of that saving. Stretching to 60 months gives the lowest payment but the highest total cost of all four plans. Compare the total, not only the payment. The payment formula guide shows how these numbers are worked out.
The biggest risk: running the cards up again
Paying off cards with a loan leaves the cards open with a zero balance. If the debt came from spending that has not changed, new card debt can pile up on top of the loan. The CFPB suggests making a realistic budget and finding the cause of the debt before you consolidate (CFPB).
Watch out for "debt consolidation" companies
- Some companies that advertise consolidation are really debt settlement or debt relief programs, which can be risky and expensive (CFPB).
- Debt settlement can hurt your credit scores, and some creditors may refuse to work with the settlement company (CFPB).
- Avoid any company that charges fees before it settles your debts (CFPB).
Alternatives to try first
- Call your card companies and ask about a lower rate or a payment plan (CFPB).
- Talk to a nonprofit credit counselor about a budget and a debt management plan.
- If you belong to a federal credit union, ask about its loans, including payday alternative loans for small amounts.
- Check your credit reports for errors before you apply (FTC); see also personal loans with a 550 credit score.
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Disclosure: Modern Lending Solutions is not a lender, loan broker or agent for any lender or loan broker, and does not make credit decisions. Any compensation we receive is paid by participating lenders, only for advertising services. This guide is general information, not financial or legal advice.
Sources
- CFPB: What do I need to know if I'm thinking about consolidating my credit card debt?
- CFPB: I've seen a lot of advertisements for companies that consolidate credit card debt. Are these legitimate?
- CFPB: What is a debt relief program and how do I know if I should use one?
- FTC: You now have permanent access to free weekly credit reports (October 2023)