Understanding how debt consolidation loans work could be the first step toward simplifying your finances and taking control of your debt. When used the right way, a consolidation loan may help you streamline what you owe, potentially lower your interest, and help to create a clear path to becoming debt-free.
If you’re stressed from juggling multiple monthly payments and feel like your debt is just moving in circles, you’re not alone—and you may not be stuck. Keep reading to find out what debt consolidation means, how it might help, and how you could confidently and successfully use it to climb out of debt.
What is a debt consolidation loan?
A debt consolidation loan is a type of personal loan that lets you combine multiple debts—like credit card balances, medical bills, or other unsecured loans—into a single monthly payment. Instead of managing several different due dates and interest rates, you pay one amount each month. By securing a loan at a lower interest rate than your existing debts, you could save some money and pay off your debt faster.
Here’s an example of how a debt consolidation might work. Imagine you have a total of $12,000 that you owe across five credit cards with various interest rates and your total monthly payments are roughly $375. If you consolidate those five bills with a loan for $12,000 at a 12% fixed APR over 48 months your new monthly payment would be approximately $316, and you’d have a defined payoff date—no surprises, no juggling.
Think of it as financial spring cleaning. By consolidating your debt, you could potentially make your finances more manageable, reduce stress, and focus on moving forward.
How debt consolidation loans work
Let’s break down how you might go about getting a debt consolidation loan:
- Gather your existing debts. This usually includes credit cards, retail cards, or personal loans
- Apply for a consolidation loan. If you think a personal debt consolidation loan is right for you, compare lenders and choose one with rates and terms that fit your goals and budget
- Get approved and receive the loan funds. Once approved, the money could either be sent to you or directly to your creditors
- Use those funds to pay off your current debts. It may be tempting to use the cash to pay for other items, but committing this money to your debt can help you build lasting financial confidence.
- Make your single monthly payment. If your new loan has a fixed rate and term—it may make it easier to budget and track progress
With fewer payments and less interest, you could gain more control over your money and make consistent progress toward your goals.
The benefits of consolidating debt
If you’re considering a debt consolidation loan, here are some potential advantages:
- Simplified monthly payments
- With just one due date and one payment to track, it may be easier to stay organized and avoid late fees or missed payments.
- Potentially lower interest rates
- If your current debts carry high variable rates (like credit cards), consolidating into a lower rate loan could save you money over time.
- A clearer timeline to payoff
- A debt consolidation loan helps you build a repayment plan tailored to your income, expenses, and financial goals.
- Potentially improved credit over time
- As you make consistent, on-time payments on your consolidation loan, your credit score may improve. Reducing your credit utilization (especially if you stop using old credit cards) may also have a positive impact.
When consolidation might not be the right move
Understanding how debt consolidation loans work also means knowing when they may not be the best fit.
- If you have a low credit score, you might not qualify for a better rate than you already have. If this sounds like you, it may be a good idea to work on improving your credit before consolidating
- If you’re at risk of adding more debt. Consolidating your credit cards only helps if you stop using them. Otherwise, you could end up with more debt than before
- If you can’t afford the new monthly payment. Even with a lower rate, if the payment doesn’t fit your budget, it could create more financial stress
Tips for success after consolidation
Once you’ve consolidated your debt, stay on track with these smart habits:
- Set up auto-pay to avoid missed payments
- Build an emergency fund to help cover surprise expenses
- Keep old credit cards open (but unused) to maintain your credit history
- Track your progress using a budgeting tool or app like Best Egg Financial Health
- Celebrate milestones—like paying down 25%, 50%, and so on
Consolidating thoughts
Now that you understand how debt consolidation loans work, you’re better suited to decide if one might be the right fit for your financial journey. Debt consolidation isn’t about running from debt—it’s about reclaiming control. Remember, consolidation is just one of many tools available. Your financial path is personal, and the right solution should fit your life and goals. Take time to explore your options, do your research, and consider speaking with a financial advisor to make a confident, informed decision.
This article is for educational purposes only and is not intended to provide financial, tax or legal advice. You should consult a professional for specific advice. Best Egg is not responsible for the information contained in third-party sites cited or hyperlinked in this article. Best Egg is not responsible for, and does not provide or endorse third party products, services or other third-party content.
