Consolidating debt involves getting one new loan to pay down multiple existing loans. Ideally, your new loan will have better terms than the debt you're repaying. For example, it may have a lower rate, a different timeline for repayment, or a fixed rate rather than an adjustable rate.

There are different ways to consolidate debt. This guide will explain the options available and will help you decide if consolidation is right for you.

What Is Debt Consolidation?

Debt consolidation allows you to change the terms of your existing debt and simplify the repayment process. You apply for a new loan from a mortgage or personal loan lender, and once your new loan is funded, you use the money to pay down multiple existing debts.

Is debt consolidation a good idea for you? It depends on the type of new loan you qualify for. If you can get a lower interest rate, you can reduce repayment costs. You can also change the type of loan from a variable rate to a fixed-rate loan if you want more certainty, or you could make your payment term shorter to save more money over the length of the loan or longer to lower your monthly payments.

Your new rate and terms will depend on the kind of consolidation loan you take out. Look at the monthly payment amount and total repayment costs to make sure you're saving by consolidating, and ensure you have a clear plan to repay your new consolidation loan.

How to Consolidate Debt Using Your Home Equity

Tapping into your home equity is one option for consolidating debt. This means you borrow against the equity in your home using a debt consolidation refinance. Here's what you need to know about these loans.

Cash Out Refinance

A cash out refinance involves refinancing your mortgage and accessing extra cash at the same time. You'll accomplish this by borrowing more than your current home loan balance. You'll use some of the funds from the cash out refinance to repay your existing mortgage and then walk away with extra money at closing that you can use to pay your debt.

A cash-out refinance could increase your monthly mortgage payment since you're borrowing more than you currently owe on your home loan. However, you can also make your payment term longer or potentially lower your rate, which could help you avoid a big monthly bill increase or even end up with a lower payment.

Just be aware that making your payoff time longer can increase total borrowing costs. Since you are tapping into your home's equity, you also need to make sure you can comfortably make the new payments to avoid putting your home at risk.

Home Equity Line of Credit (HELOC)

A home equity line of credit also allows you to tap equity. However, these don't affect your current mortgage. Instead of getting the borrowed money up front in one lump sum, a HELOC entitles you to access a line of credit that you can draw from as needed. You can use this line of credit to pay down what you owe.

HELOCs essentially act like credit cards. You can borrow as much as you want, up to the maximum limit, and payments are based on the amount you borrowed. However, the interest rate is much lower than the typical credit card interest rate since the loan is secured by your house.

It's also important to note that losing your home is possible if you can't pay, so don't use a HELOC unless you're confident in your ability to cover the costs.

Home Equity Loan

A home equity loan is a third way to tap equity. With this approach, you get a new loan that allows you to borrow a set amount. You receive the entire amount up front and can use it to pay down the debt that you're consolidating. However, unlike a cash-out refinance loan, your current mortgage isn't affected.

Your interest rate should be lower on a home equity loan compared with a credit card. However, it could be higher than on a cash out refinance loan since this is a second mortgage. The combined value of your home equity loan and current mortgage must be within your lender's allowable limits for how much of your home's equity you can borrow.

Other Ways to Consolidate Debt

Borrowing against home equity is a popular way to consolidate debt because you can qualify for affordable rates and it is often easier to qualify to borrow when your home is securing the loan.

However, there are other ways to consolidate debt that don't put your home at risk. Here are a few other ways to consolidate debt:

• Personal loan: Personal loans are unsecured loans from banks, credit unions, and online lenders. You'll need to qualify based on your credit and income. Most have fixed rates, and you receive a lump sum amount up front to repay your debt.
• Balance transfer credit card: A balance transfer card can be used to consolidate high-interest credit card debt. Balance transfer cards usually come with 0% promotional offers, so you pay no interest for around 12 to 18 months. However, you'll want to make sure you can pay off your debt in full before the 0% rate expires.
• 401(k) loan: Some companies allow you to borrow against your retirement account. While this can be an affordable loan that's easy to qualify for, you put your retirement at risk. You must make sure you can pay back the 401(k) loan to avoid a big tax hit for early withdrawal.
• Debt management plans: Usually, you'll work with a licensed credit counselor to enter into a DMP. You'll make one monthly payment, which will be distributed among your creditors. You may be able to get your interest rate lowered or some fees waived, but your accounts will typically be closed.

Pros and Cons of Debt Consolidation

If you're considering debt consolidation, it's important to think about both the pros and cons.

Debt Consolidation FAQs

Still need to know more? Here are the answers to some questions you may have about debt consolidation.

What's the Difference Between Secured and Unsecured Debt?

Secured debt is debt that is guaranteed by collateral, such as a car loan guaranteed by a car or a mortgage guaranteed by your home. Unsecured debt is debt that you simply promise to repay, such as credit card debt, personal loan debt, and medical bills. Unsecured debt usually has a higher interest rate and is harder to qualify for because it's riskier for lenders.

Does Debt Consolidation Hurt Your Credit Score?

Debt consolidation can result in a short-term hit to your credit score because you apply for a new loan to consolidate debt. This results in an inquiry on your credit record and shortens your average age of credit. However, if you repay your new debt consolidation loan responsibly, your credit should improve over time.

Is Debt Consolidation a Good Idea?

Debt consolidation can be a good option if you can qualify for a new loan with favorable repayment terms. You also need to be sure you can repay the consolidated debt and you won't end up more deeply in debt by continuing to borrow more after consolidating.

Final Thoughts: How to Consolidate Debt

Consolidating debt can greatly simplify repayment and make total payoff costs cheaper if you find the right debt consolidation loan. Be sure to explore your options, including personal loans, balance transfer credit cards, cash-out refinance loans, HELOCs, and home equity loans.

If you're interested in tapping into equity to consolidate, contact a mortgage professional today to find out about what loans are available to you and get prequalified to borrow.