How Does Debt Consolidation Really Work?

There's more to debt consolidation than making a single payment each month. Learn how it works and the most effective ways to use it.

Updated May 13, 2024
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Just about everyone in the United States carries debt, according to research from Comet. That debt load can be frustrating to manage, especially if you feel like you’ll never be able to pay it all down.

With multiple payments to keep track of each month, and different interest rates (some of them quite high), staying on top of your debt and making progress can feel like a losing battle. One way to get out of debt is to use debt consolidation.

In this article

How debt consolidation works

Debt consolidation is the process of arranging your debt so it’s all in one place. Rather than trying to juggle several payments — and possibly missing some — you streamline the situation so you only have payment to deal with. You still have the same amount of debt you started with, but it can make it easier to manage.

There are different methods for consolidating debt, including:

  • Personal loan
  • Credit card balance transfer
  • Home equity loan or line of credit
  • Debt management company

Most debt consolidation loans charge a fixed rate, so you have a better idea of what your interest charges will be, and depending on what you qualify for, you’ll potentially have a lower monthly payment.

Understanding how debt consolidation works in each of these circumstances can help you figure out how to pay off debt, depending on your current financial situation.

Debt consolidation with a personal loan

One of the most common ways to consolidate debt is by using a personal loan. I’ve used this method, and it helped me take control of my own debt situation and pay off debt faster.

With this type of debt consolidation, you get a new loan that’s big enough to pay off your other debt. Personal loans make sense when you have high-interest debt like credit cards and payday loans. My personal loan came with a 9.99% annual percentage rate (APR), which sounds high, but when you compare it to credit card and payday loan rates, it’s an improvement.

Now, instead of having several debts to manage, you only have one loan payment each month. And, because your interest rate is lower, the debt is less expensive, and you have a set period of time to pay it off.

Debt consolidation with a credit card balance transfer

Using a credit card balance transfer to pay off your other debt is similar to getting a personal loan. However, instead of getting a new installment loan, you apply for a new credit card with a 0% APR introductory rate. Sometimes this is also called credit card refinancing.

Usually, you have between 45 and 60 days to move your old balances over. Many credit cards will accept balances from other cards, as well as personal loan balances — including payday loans and car title loans. Keep in mind that you’ll likely pay a balance transfer fee of 3% to 5%, whichever is greater, so make sure your interest savings are bigger than the fee.

With a 0% APR, none of your monthly payment goes toward interest charges, so every penny goes toward reducing your balance. This can be one of the fastest ways to pay off your debt.

However, realize that the zero interest rate won’t last forever. Depending on the balance transfer credit card and your situation, you could see anywhere between six months and 24 months for the introductory rate. After the promotion period ends, your rate shoots up to the regular APR rate, which can be quite high.

A credit card balance transfer can work well if you are confident you can pay off your debt before the introductory period ends and your rate goes up.

Debt consolidation with home equity

In some cases, your existing debts may be too large to pay off with a personal loan or a credit card balance transfer.  If you’ve built up a large amount of equity in your house over time, a bank or credit union might let you use it as collateral to get a bigger loan.

Here’s how debt consolidation works in this case:

1. The lender looks at the difference between how much you owe on your home and how much it’s worth. If you owe $100,000 on your mortgage, but your home is worth $180,000, you have $80,000 equity in your home.

2. Lenders offer to give you a lump sum, or a line of credit, based on your equity. In our example, they might give you 80 percent of your equity, or $64,000.

3. You take the money and use it to pay off your high interest debt.

4. Repay your home equity loan or home equity line of credit (HELOC).

Because you secure the debt consolidation loan with your home, you can usually get a better rate than you would with a personal loan. The main risk, though, is that now you’ve taken unsecured debt and tied it to your home’s value. If you fall behind in payments, you could lose your house.

Figure Benefits

  • Incredibly fast way to turn home equity into cash
  • Borrow up to $400K; Redraw up to 100%
  • Apply 100% online, approval in 5 minutes, funding in 5 days1

Debt consolidation with a debt management company

Maybe you don’t want to get a loan — or you aren’t able to get a debt consolidation loan. If that’s the case, you might be able to get help from a credit counselor or a debt management company.

With these types of third parties, someone evaluates your debt and your budget. They put together a payment plan for you that involves you sending in one payment each month, and the debt management company sends payments to your creditors. It’s vital that you have accurate information about where to send payment so that you don’t end up with missed payments on your credit report.

In some cases, a credit counselor or debt management company will charge a fee for this service, so you need to be aware of the added cost. However, if you’re stressed about keeping track of multiple payments, it might be worth it for the extra help.

You can find reputable credit counselors at or by visiting the Department of Justice and using their credit counseling tool.

Pros and cons of debt consolidation

If you're considering debt consolidation, it's important to weigh up the pros and cons to determine if it's the right choice for you. Here are some advantages and disadvantages to consider:

  • Only one monthly debt payment
  • If you get a lower interest rate, more of your payment goes toward reducing your debt
  • You might be able to become debt-free faster
  • A clear payoff date can give you peace of mind
  • Missing or making late payments can damage your credit score further
  • Without a solid plan to stay out of debt, debt consolidation can make your financial situation worse
  • Some debt consolidation options come with fees

How much does debt consolidation cost?

With a personal debt consolidation loan, you might have to pay origination fees or late fees. Depending on the card, credit card balance transfer fees can be high. And there’s usually a fee involved when you hire a debt management company.

However, debt consolidation can be a good idea, especially if you are struggling to make your minimum payments or if you have high interest rates on your current debt.

If a new loan offers a lower interest rate and you can increase the amount of your monthly payment that goes towards paying off the principal amount, you can potentially save a considerable amount of money on your overall debt.

Be sure to check your loan terms and the fine print of the repayment terms to see if you'll face prepayment penalties if you pay before your due dates.

What about debt settlement?

It’s easy to confuse the differences between debt management and debt settlement, but they are not the same thing.

A debt management company or credit counselor might be able to help you negotiate lower interest rates so you can pay off your debt faster, but you’re still paying what you owe.

With debt settlement, you discontinue making payments to your creditors and instead send them to a third party that keeps the money in an account. They negotiate with your creditors on your behalf on agreements to pay a portion of what you owe. 

It can eliminate your debt quickly but will have longer lasting effects on your credit. To even be eligible to attempt to settle your debt this way, you’ll need to be delinquent on the payments for that account. You only make one payment each month, but you run the risk that creditors will sue you instead of settling the debt.

What happens if you want to consolidate other types of debt?

For the most part, debt consolidation is most effective when you use it on high-interest debt, like title loans, payday loans, credit cards, and personal loans with high interest rates. However, it’s still possible to consolidate other debts.

Here’s how debt consolidation works with a few other different types of debt.

Mortgage debt

There isn’t much reason to consolidate your mortgage debt with your other debts. In many cases, mortgage debt comes with a lower interest rate, and there’s a potential tax deduction for the interest you pay.

However, if you have multiple home equity lines of credit or if you have a second mortgage, you might want to consolidate all that debt. If you have enough equity in your home, you can refinance all your home-related debt, consolidating it into a new mortgage that pays off all the smaller debts.

Often, when you do this, you extend the term of your loan longer, which can end up costing you more.

Student loan debt

As with mortgage debt, student loan debt usually comes with a lower interest rate and some tax breaks. However, having several different loans can be frustrating.

If you have federal loans, you might be better off consolidating them through the Department of Education so that you maintain the protections that come with federal loans — especially if you hope to take advantage of income-driven repayment or loan forgiveness.

Private student loans can sometimes have higher rates, and they might not have the same protections. As a result, getting a student loan refinance designed to pay off all your private loans and consolidate them into one payment can make sense.

Auto loans

In many cases, rather than try to consolidate your car debt with other loans, it makes more sense to see if you can refinance your car payment to a lower rate. The only exception is if you have a car title loan.

Car title loans have such high interest rates that if you can get a lower-rate personal loan to pay them off or consolidate them with other debt, it can save you money.


Does debt consolidation hurt your credit?

When consolidating debt, you’ll notice some fluctuation in your credit score. If you’re borrowing a personal loan, you might notice it drop a bit because of the hard inquiry on your credit report. However, it should bounce back pretty quickly as you make on-time payments. 

The longer you make payments, the higher you’ll see your credit score rise. If you decide to open a new credit card and merge your credit card debt to one card, you might see an immediate spike when your credit availability increases. Overall, as you get closer to paying off your debt, you should see a positive impact on your credit score.

What is the difference between a secured and unsecured loan?

A secured loan is a type of loan that has collateral or something tangible attached to it. For example, a mortgage is a type of secured loan because a lender can reclaim your home if you aren’t making payments. You can opt to get a secured loan to consolidate your debt, but doing so risks losing a valuable item if you can’t make payments.

An unsecured loan does not have any collateral, and personal loans are a type of unsecured loan. With no collateral, unsecured loans often have slightly higher interest rates. They can also be harder to qualify for if you have poor credit history.

What is the difference between debt consolidation and bankruptcy?

Debt consolidation is the process of combining multiple debts into one loan with a lower interest rate, making payments simpler and potentially reducing the amount of interest paid over time.

Bankruptcy is a legal process that involves declaring you are unable to pay your debts. Depending on the type of bankruptcy, you may be required to sell assets to pay off creditors or create a repayment plan. Debt consolidation simplifies and reduces payments, while bankruptcy is a legal process for dealing with overwhelming debt.

Bottom line

Debt consolidation can be a useful tool if you're struggling with multiple debts. However, it's important to keep in mind that debt consolidation is not a magic fix and may not be the best option for everyone. 

Carefully consider the terms and fees associated with any consolidation loan before making a decision. With the right approach and understanding of the process, consolidating debt can provide you with peace of mind, as well as help you create a plan to get out of debt faster.

National Debt Relief Benefits

  • No upfront fees2
  • One-on-one evaluation with a debt counseling expert
  • For people with $30,000 in unsecured debts and up

Author Details

Miranda Marquit

Miranda Marquit has covered personal finance for more than a decade and is a nationally-recognized financial expert and journalist, appearing on CNBC, NPR, Forbes, Yahoo! Finance, FOX Business, and numerous other outlets.

Author Details

Lauren Stewart

Lauren Stewart is a freelance writer and personal coach. Get to know her!