How Does Debt Consolidation Really Work?

There's more to it than making a single payment each month
Last updated April 3, 2023 | By Miranda Marquit

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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.

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.

There are different methods for consolidating debt, including:

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

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% 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 time period for paying it off.

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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.

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 credit card and your situation, you’ll see anywhere between six months and 24 months for the introductory rate. After the promotion period ends, your rate shoots up to the “regular” 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, you might have too much debt to pay it all 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 line of credit.

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.

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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 with 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 use their credit counseling tool.

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. You only make one payment each month, but you run the risk that creditors will sue you instead of settle 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 date, 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.

Car 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.

The Bottom Line

Once you know how debt consolidation works, you can run the numbers to see if it makes sense in your situation. In many cases, consolidating debt can provide you with peace of mind, as well as helping you create a plan to get out of debt faster.

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Author Details

Miranda Marquit Miranda Marquit has been covering money 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.