• Debt Consolidation: How It Works and How to Choose

    Debt consolidation combines several debts into one payment, and there are six common ways to do it. Each one works differently, suits a different situation, and affects your credit in its own way. One of them, a debt management plan through a nonprofit credit counseling agency, consolidates your payments without a new loan and with no credit score requirement. This page explains how each option works, compares them side by side, and helps you decide which one fits your situation.

    What is debt consolidation and how does it work?

    Debt consolidation brings multiple debts together into one payment, so they’re easier to track and repay on terms that fit your budget. Depending on the method and your creditworthiness, it can mean fewer payments to manage, a lower interest rate, a smaller monthly payment, and a lower total cost of repayment. Consolidation reorganizes what you owe; it does not erase it, so it works best when you also address what caused the debt in the first place. Each person's situation is different, so weigh each option before you choose.

    The primary benefits of debt consolidation include:

    • Fewer monthly payments to manage
    • Lower total interest charges
    • Smaller total monthly payment
    • Reduced total cost of repayment

    What are the different types of debt consolidation?

    There are several ways to consolidate your debts. Below are the six most common, followed by an at-a-glance comparison. Each has its own credit requirements, risks, and effect on your credit, so consider how each would work in your own situation.

    Unsecured consolidation loan

    You take out an unsecured loan from a bank, credit union, or online lender and use the money to repay your outstanding debts, leaving you with a single loan to focus on. It may be your best choice if you want to get out of debt fast and have the credit score and income needed to qualify. That’s also the major disadvantage of debt consolidation with an unsecured loan: you may need a good to great credit score to get a worthwhile rate. If you’re already struggling and you’ve missed some payments, you may have a hard time qualifying for a new loan with a low interest rate. Don’t take out a consolidation loan because you assume it’s better. Make sure the loan terms are genuinely an improvement on the terms of your current debt.

    Home equity loan

    If you have equity in your home, you can borrow against that equity and use the funds to repay your debts, often at a lower interest rate. The major disadvantage is that your home is used as collateral, so you risk foreclosure if you fall behind.

    Mortgage refinance

    By taking out a new mortgage on your home, you can repay your old mortgage and other unsecured debts, leaving only the new mortgage. This debt consolidation option may help to condense your debt but may add time to your repayment, and your home is again the collateral.

    Balance transfer

    If you qualify for a balance transfer, you can open a new credit card and move your other unsecured balances onto it, ideally at a low or zero percent introductory rate. The disadvantages of this debt consolidation method include transfer fees, a rate that jumps after the short introductory period, and the risk of running up new debt.

    Debt settlement program

    In a debt settlement program, you make payments to the program rather than to your creditors, and a third party negotiates to settle your debts for less than the full amount. The key to settlement is that you're negotiating a payoff for less than what you owe. It's best suited for consumers who are people already behind on their bills who need a more extreme approach. Settling debts can have a serious negative impact on your credit, and forgiven debt may be taxable, so weigh it carefully.

    Debt management plan

    A debt management plan consolidates your payments, but doesn’t require a good credit score. Instead of taking out a new loan, you work with a nonprofit credit counseling agency and make one payment a month, which the agency distributes to your creditors on your behalf. Many creditors reduce interest rates and waive certain late or over-limit fees for accounts repaid through a plan. Financial education is usually included.

    Unlike settlement, on a debt management plan you repay your debts in full, which can help your credit once the plan is complete. Most plans are designed to fit your budget and are completed within three to five years.

    All debt consolidation options will impact your credit. Be sure to consider how it applies to your unique situation. While these debt consolidation options have the same underlying idea, each method is different from the others. It is important to make sure you understand each option before choosing a debt consolidation program.

    Debt consolidation options at a glance

    Credit requirement New loan or credit? Credit impact Main drawbacks
    Debt management plan None, because it's not a loan No, the agency pays your creditors from one monthly payment Short dip when enrolled accounts close, then positive as debts are paid in full Enrolled accounts are closed, secured debts and student loans can't be included, and a monthly fee may apply
    Unsecured consolidation loan Good credit and steady income are typically needed Yes, a new loan Can lower credit utilization ratio, but closing paid-off accounts may hurt Usually includes new loan fees, less payment flexibility, and a higher rate if your credit has slipped
    Balance transfer Good credit is usually required Yes, a credit card Adds available credit, with less utilization benefit than a loan Transfer fee, often 3 to 5%, a higher rate when the promotion ends, and the temptation to add debt
    Home equity loan or refinance Home equity is needed, and the best credit gets the best terms Yes, borrowing secured by your home Closing paid-off accounts may affect credit Your home is at risk of foreclosure if you default, and upfront closing costs can be high
    Debt settlement Accounts must be seriously delinquent No, you pay into a settlement fund Intentionally missing payments for the sake of a settlement will badly damage your credit; settlement itself may cause additional temporary damage Fees, collections may continue, forgiven debt may be taxable, and not all creditors may agree to settle
    Do-it-yourself None, you repay existing debts on your own No Positive assuming you're able to make your payments on time every month No creditor concessions or rate reductions, and success relies on your own budget

    How do you consolidate credit card debt?

    Every debt consolidation method comes with different features and different steps to get started. Here's a high level view of how to consolidate debt with each available method.

    Balance transfer, step by step

    A balance transfer suits people with good credit who can clear the balance during a card's introductory rate. If your credit is weaker, you may not qualify for the rate and terms that make it worthwhile. 

    1. Tally up your debts: amounts owed, interest rates, monthly minimums, lenders, and repayment periods.
    2. Order a credit report and check your score. Free reports from TransUnion, Equifax, and Experian are available at AnnualCreditReport.com. Dispute any errors and note that different scoring models such as FICO and VantageScore may show different numbers.
    3. Shop around for credit cards with a limit high enough to cover your balances without pushing utilization too high (ideally below 30 percent). Even a card without a zero percent APR can save money if its rate is lower than your current cards.
    4. Apply for the card, knowing the application triggers a hard inquiry that can lower your score briefly. If your credit is poor, consider a debt management plan instead.
    5. Pay off the balance within the introductory period, otherwise the rate may revert to a level higher than your original cards.
    6. Don't accrue new debt. Closing old cards can hurt your utilization, so it is often better to keep them open and practice discipline.

    Debt consolidation loan, step by step

    A debt consolidation loan is a form of personal loan used to pay off credit cards, medical bills, personal loans, or payday loans loans, leaving you with a single loan to repay.

    1. List your debts, including amounts, rates, terms, and lenders, so you can view the facts objectively.
    2. Research your options: local banks, credit unions, and reputable online lenders. Compare secured loans (backed by collateral such as home equity) against unsecured loans, and compare rates, fees, and prepayment penalties. Make sure the new rate is genuinely lower and the term is not simply longer, which would raise the total interest you pay.
    3. Build a repayment plan: set a budget, cut expenses where you can, and look for extra income.
    4. Make an informed choice, and watch for scams.

    Home equity loan, step by step

    1. Determine which debts you want to consolidate. Add up the balances of your credit cards, personal loans, and other high-interest debts.  
    2. Find out how much equity you have in your home by subtracting your remaining mortgage balance from your home's current market value. Lenders typically require you to maintain a certain amount of equity, often at least 15% to 20%, after taking out the loan.
    3. Shop around with banks, credit unions, and other lenders for home equity loan offers. Compare interest rates, repayment terms, closing costs, fees, and monthly payments.  
    4. Apply for a home equity loan. You'll typically need to provide proof of income, mortgage information, and other financial documents. The lender may also require a home appraisal.
    5. Use the loan proceeds to pay off your existing debts. You'll then make one monthly payment on your new home equity loan, in addition to your existing mortgage payment.
    6. Avoid adding new debt. Adjust your budget to accommodate the new loan payment and avoid running up balances on credit cards you've paid off.

    Debt management plan, step by step

    1. Work with a certified credit counselor to review your budget and determine if a debt management plan is right for you.
    2. Begin making debt payments directly to the plan administrator. You may need to contact your creditors to shift your due dates to match the new payment date associated with your plan.
    3. Stay in contact while the plan administrator begins negotiating with your creditors on your behalf. The first 30-90 days may include a fair amount of back and forth with your creditors as your new account terms are out into place.
    4. Close any accounts that are included on your plan. Your creditors will almost all require that accounts be closed at the start of the program.
    5. Make payments regularly each month. You may risk losing benefits if you miss multiple payments.
    6. Don't add more debt and stick with it until the end. You may be able to roll additional debts into your plan, but that would almost certainly extend the length of your program.

    Debt settlement, step by step

    1. Make a list of your outstanding debts, including balances, interest rates, monthly payments, and creditors.  
    2. Determine if debt settlement is right for you. Settlement can have a deeply negative impact on your credit, but if you can't afford to pay your debts in full it may be the best option.
    3. Compare debt settlement options. You can negotiate directly with creditors or work with a debt settlement company. Lower cost, nonprofit debt settlement is available from MMI through our debt resolution plan (DRP).
    4. Build a fund for your settlements. Debt settlement typically involves saving money to offer creditors a lump-sum payment or a series of payments that total less than the full balance owed.  
    5. Negotiate with creditors. Find the partial payment amount that will satisfy the creditor and allow the rest of the debt to be forgiven.
    6. Pay the agreed-upon settlement amounts. Once a creditor accepts an offer, get the agreement in writing before making payments, then follow the agreed payment schedule and keep documentation showing that the debt has been resolved.
    7. Start rebuilding your credit and your finances. Debt settlement can help wipe the slate clean, but it'll take some time for your credit to recover. Having a plan for life after settlement can help accelerate that recovery.

    Red flags: avoiding debt consolidation scams

    Check any lender with the Better Business Bureau (BBB) and the Consumer Financial Protection Bureau (CFPB) before you apply.

    A major red flag is any lender asking for money up front, during the application. It should be free to apply for a legitimate loan.

    Do-it-yourself payoff methods

    You don't need a new product to make progress. If you can commit to a plan, these do-it-yourself methods pay debt down without new borrowing or a credit requirement:

    • Debt avalanche: pay the minimum on everything, then put every extra dollar toward the debt with the highest interest rate first. This saves the most interest.
    • Debt snowball: pay the smallest balance first for early, motivating wins, then roll that payment into the next smallest balance.
    • Debt blizzard: clear the smallest balance first for a quick win, then switch to the highest interest rate onward. It combines both approaches.

    What are the disadvantages of debt consolidation?

    There are potential disadvantages to every method. Whichever you choose, keep the following in mind:

    • Some methods require good-to-excellent credit.
    • When you add unsecured debt to your mortgage, you risk falling behind on your mortgage payments.
    • Consolidating creates a single large payment instead of several small ones, and one missed payment can damage your credit significantly.
    • Consolidation can help you repay your debt, but it may lead to more debt if you don't address the root cause.

    Before you commit, make sure you understand the risks and how the features of your chosen option fit your own financial habits.

    Learn more about credit and debt consolidation:

    Still have questions about debt consolidation? Check out the links below or connect with one of MMI’s trained credit counselors to guide you through the process.

    • Frequently asked questions

    Is debt consolidation a good idea?
    Debt consolidation can be a good idea when it lowers your interest rate, reduces the number of payments you manage, and fits a budget you can keep. It works best when you also address what caused the debt, because consolidation reorganizes what you owe rather than erasing it. It is less helpful if a new loan simply stretches the same balance over a longer term at a similar rate, which can raise the total interest you pay. If your credit makes a low rate loan hard to qualify for, a debt management plan through a nonprofit credit counseling agency can consolidate your payments with no credit score requirement.
    Does debt consolidation hurt your credit?
    It depends on the method. Applying for a consolidation loan or a balance-transfer card usually triggers a hard inquiry, which can lower your score by a few points for a short time, and opening a new account lowers the average age of your accounts. Moving balances off your cards can help your credit utilization if you keep the old cards open. A debt management plan does not require a credit check to start and does not lower your score for applying. As you make on-time payments and balances fall, your credit often improves over the life of the plan. Debt settlement has the largest negative impact, because it typically involves missing payments and having debts reported as settled for less than the full amount.
    Can you consolidate debt with bad credit?
    Yes. Most consolidation loans and balance-transfer cards require good-to-excellent credit to qualify for a rate low enough to help, which can put them out of reach if your credit is already strained. A debt management plan is the one consolidation option with no credit score requirement: you qualify based on your budget and your creditors, not your score. You make one monthly payment to a nonprofit credit counseling agency, which distributes it to your creditors, often at reduced interest rates.
    What's the difference between a debt consolidation loan and a debt management plan?
    A debt consolidation loan is new borrowing: a lender pays off your existing balances and you repay the single new loan, usually after a credit check, and the loan is a commercial product from a bank, credit union, or online lender. A debt management plan does not involve a new loan. You work with a nonprofit credit counseling agency that consolidates your payments, not your debt, into one monthly payment it distributes to your creditors, often at reduced interest rates, with no credit score requirement to start. In short, a loan consolidates your debt into a new balance you owe a lender, while a debt management plan consolidates your payments without new borrowing.
    How do you consolidate credit card debt?
    The common routes are a balance-transfer card, a debt consolidation loan, or a debt management plan. With a balance-transfer card you move several card balances onto one card, ideally with a low or zero percent introductory rate, and pay the balance off before the promotional period ends. With a consolidation loan you borrow enough to pay off the cards and then repay the one loan. With a debt management plan you make a single monthly payment to a nonprofit credit counseling agency, which pays your card issuers on your behalf, often at reduced rates and with no credit score requirement. Which one fits depends mainly on your credit and on whether you want to take on new borrowing.
    Is nonprofit debt consolidation different from a debt consolidation company?
    Yes. Nonprofit refers to how the organization is structured, not to a type of loan. As a nonprofit credit counseling agency, MMI offers a debt management plan along with free or low cost financial counseling, and its focus is education and a workable repayment plan rather than selling you a loan. A for-profit debt consolidation company typically sells a product, such as a consolidation loan or a debt settlement program, and earns revenue from fees or interest.
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    You don't have to go it alone

    Debt can feel overwhelming, but you have options, and help is available. A conversation with a nonprofit credit counselor can help you compare these choices against your own budget and decide what fits, with no obligation.


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