How to consolidate debts

When are debt consolidation loans the right choice?

The goal of debt consolidation is to help you manage your monthly payments, pay down what you owe, and ultimately pay off your debts.

If you are considering consolidating your debt, a good first step is to look at how much your monthly debt payments are and how much you owe in total. Next, look at your income and other money you might have to pay your debts. It can be helpful to create a budget of your monthly expenses for food, clothing, shelter, utilities, and debt payments and what you spend on dining, entertainment, hobbies, and travel.

Next, you’ll want to decide if a debt consolidation loan like a cash out refinance is the right choice for you. Depending on the amount of your debts, it might make more sense to create a debt payment budget or consider debt relief.

Working with a credit counselor can help you make the right decisions. Visit the Consumer Finance Protection Bureau’s website for information on how to find a qualified credit counselor.

When should you choose a debt consolidation loan?

Debt consolidation loans often make sense when you have moderate levels of debt—that is, debts you cannot pay off quickly with your existing income.

Debt consolidation loans let you pay off smaller debts and consolidate them into a new loan. These loans can make sense when you have high-interest debts from things like credit cards. That’s because loans like cash out refinances typically have lower interest rates than credit cards. As a result, you may be able to lower your interest payments and apply the savings to paying down your debts.

Before you choose a debt consolidation loan, make sure you can afford the new loan payment. Also look at the fees, closing costs, and interest, and decide if paying these costs makes sense to you. You will need to meet your lender’s credit, income, and financial requirements to get your loan approved.

When cash out refinances are used to consolidate debts, they are sometimes called debt consolidation mortgage refinances.

When should you choose a debt payment budget?

Debt payment budgets are often good choices when you have low levels of debt—that is, debts you can pay off quickly with your existing income. That’s because consolidation loans include costs and fees you’ll have to pay to your lender. It might make more sense to use this money to help pay off your debts instead.

Summarizing your monthly expenses can help you create a debt payment budget. Look for places where you can reduce your spending and apply the savings to paying down debts. For example, if you spend money on restaurants, you could eat at home more until you’ve paid off your debts.

When should you think about debt relief?

When you have high levels of debt, debt relief might be your best option. Financial professionals often say you have a high level of debt when your monthly debt payments are more than 50% of your monthly gross income. For example, if your monthly income is $5,000 and your monthly debt payments are more than $2,500, you could be considered to have a high level of debt.

A high level of debt can also mean you don’t have a realistic chance of getting your debt payments under control even when you reduce your spending and get a debt consolidation loan.

Debt relief can include contacting your lenders and seeing if you can negotiate more affordable loan terms or minimum payments. You can try negotiating a reduction of the total amount you owe as well. Filing for bankruptcy is also a form of debt relief. You’ll want to think carefully about the pros and cons of bankruptcy before you choose this option, however.

Be wary of debt settlement companies especially when they make promises that sound too good to be true. These companies often charge high fees and do not deliver the results they promise. Instead consider finding a qualified credit counselor to help you understand your debt relief choices.

What’s the difference between secured and unsecured debt?

Secured debt is a loan guaranteed by collateral such as your car or your home. Unsecured debt is a loan not guaranteed by collateral. Personal loans and credit cards are examples of unsecured debt.

Secured debts often have lower interest rates compared to unsecured debt but come with the risk of the lender repossessing your car or taking ownership of your home if you fail to make your payments. As a result, financial professionals usually recommend you prioritize making payments on secured debts before you make payments on unsecured debts.

Freedom Mortgage 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. By refinancing, the total finance charges you pay may be higher over the life of the loan.

Last reviewed and updated October 2023 by Freedom Mortgage Corporation.