Updated on 01.09.17

Should I Consolidate My Debt?

The average American is carrying $5,540 in credit card debt, according to an analysis of Federal Reserve data by CreditCards.com. Among those who usually carry a balance, that number spikes to $7,494 — per card. If you’re among the Americans carrying big balances on high-interest credit cards, you might be wondering whether you should consolidate your debt.

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There’s no doubt about it: Having less debt is better than having more. In fact, lower balances correlate very strongly to higher credit scores. There are a number of advantages to debt consolidation — it can help you get out of debt, and improve your credit score to boot. But is it right for you?

The Advantages of Consolidating Debt

There are three main advantages of consolidating your debt.

First, there’s the small matter of getting out of debt. Even if you’re buried under credit card balances, you’ll generally want to avoid settling your debts. They’ll be marked down as settled, meaning that you paid less than what you owe. That’s never a good look on your credit report.

However, where you can save money is on a lower interest rate. Cutting your interest rate means more of your money will be going toward the principal balance, not interest — which means your debts will be paid off sooner. Especially if you have an egregiously high credit card rate, the savings can be significant.

The other advantage of consolidating your debt is a potential boost to your credit score. As mentioned above, a lower credit utilization ratio (the percentage of your credit that you’re actively using — i.e., your credit card debt) correlates strongly to having a better score. That’s because, after timely payments, the second biggest factor in your credit score is having low levels of debt.

Finally, you might find it easier to pay a single bill every month rather than three or four or more. That’s going to help you pay down your debt faster by not saddling you with credit card fees for late payments. It can also help you avoid torpedoing your credit score any further by missing payments.

The Disadvantages of Consolidating Debt

Of course, if consolidation loans were always the right answer, everyone would be using them. So what are some reasons you might not want to consolidate your debt?

First, ask yourself — and be honest: Are you going to just charge up more debt? It’s no good to take all that debt off of your credit cards if you’re just going to load them up again. If you fit this profile, a consolidation loan might be the biggest financial mistake of your life.

You also need to look at any fees associated with the loan, including fees for early repayment. Loans are not credit cards. Banks expect that it’s going to take you a certain amount of time to repay the loan. If you pay it off sooner than that, they’re going to lose money on the interest you would have paid, so they may whack you with a charge for paying off your debt early.

If your credit has been dinged up by whatever spending landed you in debt, you may not qualify for a consolidation loan with favorable rates. It’s usually not worth taking out a new loan if the terms are no better than what you’re paying on your existing credit cards.

Meanwhile, some banks require collateral for consolidation loans. If you’ve gotten into unmanageable debt in the past, you’re at a higher risk of getting into unmanageable debt again. Are you willing to lose whatever you may need to put up for collateral? That’s an important question when going to a bank for a secured consolidation loan.

Alternatives to Consolidating Debt

A consolidation loan isn’t the only way to consolidate your debt. You can also get more credit cards.

Why would you want to do that? So that you can take advantage of 0% interest introductory offers using a balance transfer. In fact, in many cases, this is going to be a better option simply because of the rock-bottom interest rate. In most cases, you’ll have 12 months or more to pay down your balance without any paying any interest, allowing you to make faster progress.

Gone are the days when credit card companies hit you with a lot of back interest for not paying off your transferred balance in its entirety before the introductory rate expires. So even if you get “close, but no cigar” to paying off your outstanding debt on the new card, you’re still going to come out ahead.

The rub is that they generally charge a balance transfer fee of about 3% — that would be $300 on a $10,000 balance — so make sure you’re going to be saving enough on the interest charges to make it worth your while. Otherwise, this should be your first stop on the debt consolidation road before taking out a loan.

When Consolidation Makes Sense

The main reason you should consolidate your debt is if you’ve gotten in over your head and are willing to make changes to your spending to get yourself back above water. It can be a useful tool to simplify your payments, pay less in interest, and make faster progress on your balances. But if you don’t change the behavior that got you into this mess in the first place, a new line of credit isn’t going to change anything and could even dig you deeper into debt.

When you decide to consolidate debt, you ideally want to pay off your outstanding debt in a year or less, and certainly no more than three years. If you can’t even pay it off in five years, it might be time to bypass consolidation and start thinking about talking to a bankruptcy lawyer.

Debt consolidation isn’t for everyone, but for many people it can be a very shrewd move to get your finances back on track.

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