Updated: Aug 17
Debt consolidation is when you take out a loan in order to pay off multiple other debts at once. Typically a person will take out a debt consolidation loan and use that money to pay off things like credit card balances and high-interest loans. There are a few nice benefits of debt consolidation:
Simplify finances with one monthly payment instead of making multiple payments every month
Decrease overall interest rate - particularly if consolidating high-interest credit card debt
Lower monthly payments - lower overall interest rate and/or longer repayment plans could result in a lower payment due every month
Higher credit score - making regular, on-time payments on a debt consolidation loan and lowering your credit utilization rate can improve overall credit scores
Is debt consolidation a good idea?
Debt consolidation loans usually require a hard credit check during the application process, which has an immediate negative effect on credit scores. However, making on-time payments, eventually paying off the debt consolidation loan, and broadening overall credit mix can have a positive, long-term effect.
But (there's always a but!) taking out a debt consolidation loan in order to pay off credit card balances, for example, and then running those credit cards up again is a slippery slope. This pattern can lead to a snowballing effect of needing more/larger loans to pay off previous loans plus new credit card balances, lower credit scores, and higher overall interest rates.