Debt consolidation can make managing your debts easier. It often involves getting a debt consolidation loan, which you use to pay off smaller debts and make a single payment on the new loan instead.
Debt consolidation makes the most sense when the new loan has a lower interest rate than the rate on the debts you are paying off. This helps you save money on interest payments and use that savings to pay down the principal instead. Is debt consolidation a good idea for you? Check out these pros and cons!
What are the pros of debt consolidation?
- Save money on interest payments. Debt consolidation loans often have lower interest rates than other kinds of debts. For example, credit cards can have 20% interest rates while cash out refinances might have rates in the 6% to 7% range. As a result, debt consolidation might help you lower your interest payments.
- Pay down debts faster. When you take the money you save on interest payments and use it to pay down your debts, this can help you get out of debt faster.
- Pay bills more easily. Consolidating your debts gives you one bill to pay on one due date, rather than several bills to pay on several dates.
- Make payment amounts predictable. Debt consolidation loans often have fixed interest rates, which means your monthly principal and interest payments won’t change.
What are the cons of debt consolidation?
- Consolidation does not eliminate debts. A debt consolidation plan can help you manage your debts and save money on interest payments. It does not eliminate your debts. Only paying down and paying off your debts does that.
- Consolidation loans have closing costs. Debt consolidation loans typically have closing costs which you will need to pay. You’ll want to balance these costs against interest savings and other loan benefits.
- Risks if you miss payments on your new loan. You’ll want to make sure you can afford your new monthly payment, especially when your debt consolidation loan uses your home as collateral.
- Opportunities to increase your debts. Consolidating your debts can make it easier to take on more debt. For example, if you pay off your credit card balances with a debt consolidation loan, this can make it possible for you to make new charges on that credit card. When your spending habits are a cause of your debt problems, you’ll need to change those habits or you can end up owing more money rather than less.
A debt consolidation counselor or financial professional can help you decide if debt consolidation is a good choice for you. These professionals can also help you come up with a consolidation plan that will pay down and pay off your debts. Learn more about how to consolidate debts.
Freedom Mortgage Corporation is not a financial advisor. The ideas outlined above are for informational purposes only, are not intended as investment or financial advice, and should not be construed as such. Consult a financial advisor before making important personal financial decisions and consult a tax advisor regarding tax implications and the deductibility of mortgage interest.
Last reviewed and updated February 2023 by Freedom Mortgage Corporation.