How does debt consolidation work?

Debt consolidation allows you to stop juggling multiple debt payments and may even save you some money on interest charges

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Debt consolidation works by combining multiple debts into one. It can lower your interest rate and help you get out of debt sooner. Learn more. (iStock)

Being in debt can feel overwhelming — especially if you’re juggling multiple monthly payments. Americans carried more than $784 billion in credit card debt alone in 2021, with an average balance of $5,221, according to an Experian consumer debt study.

If you’re struggling to stay on top of all your debt payments, consolidating your debt may be a useful strategy.

Here’s what you should know about debt consolidation, how it can benefit you, and how it can affect your credit score. 

A personal loan can be a great tool for consolidating high-interest debt. With Credible, it’s easy to see your prequalified personal loan rates from various lenders in minutes.

How does debt consolidation work?

Debt consolidation involves combining multiple sources of debt into one. To do this, you’ll typically need to open up a new loan or credit card and then use it to pay off your existing balances. Streamlining multiple payments into one can make your debt easier to manage, and it may even help you save some money in the long run. 

For example, let’s say you have three credit cards: One credit card has a balance of $5,000 and a 15% APR, another card has a balance of $2,000 and a 19% APR, and the last card has a balance of $3,000 with a 21% APR. If you put $400 total toward all your balances each month, you’d pay $2,748 in interest and it would take you 43 months to pay off your debts. 

But if you consolidated your $10,000 credit card balances to a personal loan with a 12% APR and repayment terms of 36 months, your monthly payment would be $332. You’d pay $1,957 in interest and be debt-free seven months sooner. 

3 ways to consolidate debt

Now that you have a better understanding of how debt consolidation can benefit you, the next step is to learn how to do it. You have three main options for consolidating your debt, and the one that works best for you will depend on the types of debt you have.

Debt consolidation loan

Debt consolidation loans are unsecured personal loans that you can use to consolidate debt. You’ll apply for a debt consolidation loan with a personal loan lender. If you’re approved, you’ll receive a lump sum of money up front that you can use to pay off your high-interest debt. Some lenders will even pay your creditors for you directly. You’ll then start making monthly payments on your debt consolidation loan for a set period of time.  


  • Typically comes with lower interest rates than credit cards
  • Fixed monthly payments can make budgeting easier
  • Clear end date for when you’ll pay the loan off


  • May have an origination fee for processing the loan or a prepayment penalty fee if you repay the loan ahead of schedule 
  • No introductory interest rate period like some credit cards offer
  • Once you pay off credit cards with the loan, you may be tempted to make new credit card purchases and rack up more debt

If you’re looking for a debt consolidation loan, visit Credible to compare personal loan rates from various lenders, all in one place, without affecting your credit score.

Balance transfer credit card

Balance transfer credit cards are designed for debt consolidation. You’ll apply for the card with a credit card issuer. If you’re approved, you can transfer your existing credit card balances to the new card. Balance transfer cards often come with an introductory 0% APR for a set period of time, and the credit card company may waive balance transfer fees during the promotional period as well. 


  • Often comes with an introductory 0% APR offer 
  • During the promotional period, you can work on paying down your balance without accruing additional interest
  • Opening a new credit account can lower your credit utilization ratio (how much credit you’re using compared to how much available credit you have)


  • You typically need good to excellent credit to qualify for a balance transfer credit card 
  • May have to pay a fee for each transfer (typically 3% to 5% of the transferred amount) 
  • Carrying a balance when the card’s promotional period expires can result in hefty interest charges


Student loan consolidation

If you have multiple federal student loans, you have the option to consolidate them into a federal Direct Consolidation Loan. Your interest rate will be a weighted average of your existing loans, so it may not be lower. But you’ll only have one payment to keep track of, which can make budgeting easier. 

You can also refinance federal and private student loans into a new private student loan, ideally giving you a lower interest rate. But refinancing federal student loans into a private student loan can cause you to lose certain benefits and protections, like income-driven repayment plans and student loan forgiveness. 


  • Streamlines multiple loan payments into one
  • You may save money on interest charges
  • Can pay off loans sooner if you choose a shorter repayment term (though your monthly payment will likely be higher)


  • Choosing a longer repayment term will result in a lower monthly payment, but you’ll pay more interest over the life of the loan
  • Refinancing federal student loans into a private loan will mean losing access to federal benefits
  • May not qualify for private student loan refinancing if you don’t have a solid credit history or a cosigner

Debt consolidation vs. debt settlement

Although the two terms are often used interchangeably, debt consolidation and debt settlement are actually two very different methods for managing debt. Debt consolidation involves combining multiple balances into a single payment, while debt settlement involves settling with your creditors for less than the total amount that you owe.

While paying less than you owe may sound tempting, pursuing debt settlement can negatively affect your credit score. If your debt is reported as settled, it can show up on your credit reports for up to seven years, which can make it more difficult to borrow money in the future.

When debt consolidation makes sense

The main benefit of debt consolidation is that it can make staying on top of your payments more manageable. And consolidating debt can actually help you improve your credit score in some cases by lowering your credit utilization ratio and improving your credit mix (the different types of open credit accounts you have).

Here are a couple scenarios when debt consolidation may make sense: 

  • You want to reduce your number of monthly payments. Consolidating debt allows you to combine multiple monthly payments into one single payment.
  • You want to lower your interest rate. Consolidating debt may allow you to get a lower interest rate, which can help you save money over time. 


When debt consolidation doesn't make sense

While it can have several benefits, consolidating your debt may not be the best option in these situations: 

  • You only have a small amount of debt. If you only have a small amount of debt, it likely makes more sense to put your energy into making the largest payments possible rather than moving your debt around or paying additional fees to take out a new loan.
  • You’ve had success with other debt payoff methods. If you’ve been able to pay down debt before using a free strategy, like the debt avalanche or debt snowball methods, you may be able to use these methods again to pay down your debt. 

How debt consolidation affects your credit score

Debt consolidation can affect your credit score in a few different ways. Applying for a new loan or credit card can temporarily lower your credit score at first, because the lender or credit card company will do a hard credit pull to review your credit reports. 

Over time, consolidating debt can lower your credit utilization ratio, and it can also improve your credit mix, which can increase your score. If you make all your payments on time it can also give your score a boost, since your payment history is the most important factor that determines your credit score.

But if you make late payments or miss a payment on your debt consolidation loan, it can negatively affect your credit. If you’re tempted to overspend and run up credit card balances after you’ve paid them off with a debt consolidation loan, this will raise your credit utilization, which can also hurt your score. If you’re worried about getting back into debt, consider speaking with someone from a nonprofit credit counseling agency. A credit counselor can help you make a budget and provide tools to help you meet your financial goals.  

Pursuing a debt consolidation loan can be a useful tool to help get your finances back on track. If you’re ready to apply for a debt consolidation loan, use Credible to quickly and easily compare personal loan rates to find an option that best suits your needs.