Should I Consolidate my Debt?

The average American is carrying over $5,000 in credit card debt, according to an analysis of Federal Reserve data by CreditCards.com. For those that carry a balance, that number normally spikes to over $7,000 per card.

If you’re carrying big balances on your high-interest credit cards, you might be wondering what you can do. One option is to consolidate your debt into a single payment, but it’s not the right choice for everyone.

What is debt consolidation?
Debt consolidation rolls high-interest debts, such as credit card bills, into a single lower-interest payment. It can reduce your total debt and reorganize it so you can pay it off faster.

If you’re dealing with a manageable amount of debt and just want to reorganize multiple bills with different interest rates, payments and due dates, debt consolidation is a sound approach.

How does debt consolidation work?
There are two primary ways to consolidate debt, both of which concentrate your debt payments into one monthly bill. However, you'll likely need good credit to qualify:

Get a 0% interest, balance-transfer credit card: Transfer all your debts onto this card and pay the balance in full during the promotional period.
Get a fixed-rate debt consolidation loan: Use the money from the loan to pay off your debt, then pay back the loan in installments over a set term.

Two additional ways to consolidate debt are taking out a home equity loan or 401(k) loan. Note that these two options involve risk — to your home or your retirement. In any case, the best option for you depends on your credit score and profile, as well as your debt-to-income ratio.

When debt consolidation is a bad idea
Consolidating your debt won’t solve your problems. If excessive spending habits that created the debt in the first place aren’t curbed, you can end up overwhelmed again by debt. If you accumulate more credit card debt, then your consolidation loan would become a big mistake.

If your debt load is small - you can pay it off within six months to a year – and you’d save only a negligible amount by consolidating, don’t bother. Instead, try a do-it-yourself payoff method such as the debt snowball (a method of debt repayment in which the debtor lists each of his/her debts from smallest to largest (not including the mortgage), then devotes extra money each month to paying off the smallest debt first while making only minimum monthly payments on all of the other debts) or debt avalanche (a type of accelerated debt repayment plan. Essentially, a debtor allocates enough money to make the minimum payment on each source of debt, then devotes any remaining repayment funds to the debt with the highest interest rate).

You also have to consider if there are any fees associated with the loan, including fees for early repayment.

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

Note that some financial institutions 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. If you’re in serious trouble – if the total of your debts is more than half your income – seek debt relief.