With debt consolidation, you can save time and money with a single fixed-rate monthly payment. Here’s how it works and why it could be the right move for you.

What Is Debt Consolidation?

It’s a form of debt refinancing that combines multiple balances from credit cards and other high-interest loans into one loan to be repaid in monthly installments.

One way it can save you money is by lowering your interest rate or making it easier to erase your debt faster. Debt consolidation can also reduce your monthly payment.

Such a loan can help improve your credit profile too, by demonstrating that you can make monthly payments on time, and reducing your total debt.

Is It A Good Idea?

It is if you are mired in high-interest debt and can get a loan with a lower interest rate than the aggregate rate on your current debts. That’s all contingent on you keeping up with your payments each month, though.

And because debt consolidation loan interest rates are usually fixed, you pay the same monthly amount until the debt is clear. With credit cards, annual percentage rates (APRs) can fluctuate.

You can apply for a loan through a bank or credit union or a digital peer-to-peer company. For traditional lenders like banks, though, you’ll have to have a qualifying credit score, a history of on-time payments on other loans, and a debt-to-income ratio that shows you can handle the monthly bill. By contrast, peer-to-peer lenders tend to have less-rigid requirements and consider factors such as employment history and education level in addition to your credit profile.

How Debt Consolidation Works

These loans are kind of like balance transfer cards, but with some differences. For one thing, fees on balance transfers usually run between two percent and five percent, unless you choose a no-fee balance transfer card. Also, most of these transfer cards require excellent credit, while individuals with good and fair credit can often find personal loan options.

Note that with a balance transfer, you’re merely moving balances from one account into another. With consolidation loans, the funds are deposited right into your bank account. After using the cash to wipe out your credit card debt, you’ll make monthly payments to the lender to repay the loan.

Interest, Terms, And Fees

The APR on your consolidation loan could be as low as four percent, depending upon your credit score. By way of comparison, credit card interest averages roughly 16.6 percent. 

You can get a loan for anywhere from six months to seven years, and your monthly payments will be lower the longer the term. Be mindful, though, you’ll pay more in interest over time if you elect a longer-term loan. So, it’s usually best to pick the shortest term you can afford.

You may have to pay a sign-up fee, although there are some lenders that don’t charge them, depending on the borrower’s score. Shop around.

Before you apply for a personal loan, check the websites of lenders you’re interested in to see what APR you prequalify for. You can usually accomplish this by punching in your birth date, social security number, annual income, contact info, and employment status.

Do not consolidate unless you’re offered a rate that’s lower than what you’re paying on existing debt. In fact, the most important factor when considering applying for a debt consolidation loan is the interest rate.

Now that you know how to save money with a consolidation loan, you can, with confidence, assess your financial situation and see whether debt consolidation is a viable option for you.