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Debt Consolidation: How Does It Work, and Is It Right for Me?

Debt consolidation is a way to refinance your debt by combining it into one monthly payment.

Justin Cupler

Contributing Writer at Tally

May 5, 2022

If you’re dealing with debt and are looking for a way to simplify the payoff process, debt consolidation may be right for you.

Debt consolidation is a way to refinance your debt by taking secured and unsecured debts and combining them into a single monthly payment. You can do this in a few ways, including taking out a debt consolidation loan, securing a personal line of credit or performing a credit card balance transfer.

But before making a decision, it’s best to do your research to see if it’s the right move for you. 

Here’s a quick overview of how debt consolidation works, the pros and cons, and how it could affect your credit.

How does debt consolidation work?

Debt consolidation combines your high-interest loans into a single payment that has a lower interest rate or annual percentage rate (APR). The idea is to simplify your debt payment by focusing on one new loan payment.

Debt consolidation can help reduce the amount you’ll pay in interest during the life of your current loans, which can help save you money. It can also help you pay off your higher-interest debt faster.

Common ways to consolidate debt

There are many ways to consolidate debt, but three of the most common debt consolidation options are:

  • Debt consolidation loan: You take out a fixed-rate loan to pay off all your existing debts. You can get the loan from a local bank or credit union or even through an online loan company. You often have the option of having the loan deposited into your bank account in several business days or automatically disbursed to your creditors. Then, you repay the loan over a specified amount of time. Because this is a fixed-rate loan, your monthly payments stay the same throughout the loan term.

  • Balance transfer: You open a new credit card with a low introductory promotional APR. The low interest rate is generally good for 12 to 18 months. You then transfer your existing debts onto the balance transfer credit card, so they accrue little to no interest. You can then determine the minimum payments you must make to repay the balance transfer before the promotional APR expires.

  • Personal line of credit: A personal line of credit gives you an unsecured line of credit with an interest rate that’s lower than most credit cards. You then use this line of credit to pay off high-interest debts.

Other ways to consolidate debt include using a home equity loan, a home equity line of credit (HELOC) or a 401(k) loan.

You get a relatively low interest rate with a home equity loan or HELOC, but the bank puts a lien on your home. If you default on the loan, the lender can foreclose on your home.

With a 401(k) loan, the interest you pay is to yourself, so it’s essentially a 0% interest loan. However, until you repay the loan, you’re missing out on valuable compound interest in your retirement account.

Debt consolidation vs. balance transfer vs. personal line of credit

If you’re looking for debt relief, debt consolidation might be right for you. Let’s take a closer look at the three debt consolidation tools mentioned above.

Debt consolidation

A debt consolidation loan is a type of personal loan in which you use the loan proceeds to pay off existing high-interest debts. This gives you one easy payment per month that you pay back within an agreed-upon time frame.

The benefits of a debt consolidation loan are having one constant loan payment amount and, often, a lower interest rate than what you were paying before.

Balance transfer

A balance transfer is a way to move your existing debt to a credit card with a lower introductory interest rate — often called a promotional rate. If you can transfer all your balances, you’ll have a single payment to focus on. You also have a specified time to repay your balance before the introductory interest rate expires.

Once the introductory interest rate expires, you should expect to face a higher APR. This post-promotion APR will be listed in the credit card terms you agree to. Read the fine print carefully because you may face penalties and could lose out on the introductory offer entirely if you miss even one payment. 

You must also account for the 3% to 5% balance transfer fee the credit card company will charge you for using this service. 

Personal line of credit

A personal line of credit is a credit line with an interest rate that’s often lower than most credit cards. You can use the line of credit to pay off your credit cards, saving interest charges and speeding up the process. 

The added benefit of a personal line of credit is that it’s a revolving debt, meaning if you can’t pay off all your debts in one shot with it, you can reuse it to repay any leftover debt as you pay down the line of credit’s balance. 


What types of debt can you consolidate?

Many people use debt consolidation for credit cards, but you can use it for many types of secured and unsecured debt, including:

  • Auto loans

  • Payday loans

  • Personal loans

  • Student loans

  • Medical bills

  • Taxes

Should I consider debt consolidation?

Debt consolidation isn’t for everyone; it typically works well for people with a reasonable amount of debt who are looking to simplify payments. Debt consolidation is also a solid option if you have a good credit score and a plan to pay off your debt in a timely manner. 

Having a good credit score will help you get the most favorable rates possible. This is important because it doesn’t make financial sense to consolidate debt if the new interest rate is higher than what you’re already paying.

Whichever option you choose, debt consolidation works if you make a solid plan to pay it back. If you fear falling behind on credit cards and other payments and are certain that having one lower payment will help you tackle your debt, then consolidating your loans can help.

What’s the downside to debt consolidation?

There are a few cases when debt consolidation isn’t a good idea. 

If your debt is minimal and you won’t save that much by consolidating your loans, you’re likely better off staying the course and not pursuing debt consolidation. Work to pay it off on your own, and set up a realistic timeline to hold yourself accountable.

In this case, following a streamlined debt-repayment process, like the debt snowball or debt avalanche, might help.

Debt consolidation might also be wrong for you if you find that you’re barely making your debt payments by their due dates or haven’t yet addressed the real reason you got into debt — for some, freeing up cash flow is an invitation to spend more.

If your credit score is below average due to blemishes on your credit history, then a debt consolidation loan could cost you more money. With bad credit, you might end up with a high interest rate, which defeats the purpose of consolidating your debt. 

Some debt consolidation loans will include extra fees that can drive up the loan cost. Common ones include an origination fee on loans and a balance transfer fee on credit cards. 

Make sure to read the full cost of the loan in the terms and conditions of the loan offer before signing anything, and compare it to the interest you’ll pay on your current debts over the same period.

In all cases, you run the risk of falling further into debt or missing payments, which can further damage your financial situation.

Will debt consolidation hurt my credit?

There are a few instances in which debt consolidation can lower your credit score:

  • When you apply for a loan: Creditors conduct what’s called a hard credit inquiry to review your full credit report and determine your creditworthiness. This hard inquiry can negatively impact your FICO credit score for up to 12 months.

  • When you take on new debt: When you start debt consolidation, it usually begins with you taking out a new loan or credit card. This means a new account on your credit report, which can negatively impact two FICO variables — length of credit history and new credit — potentially causing your score to fall. The one exception is if a credit card you currently have offers you a special balance transfer rate.

  • When you close your accounts: Your credit score could be lowered if you close your accounts as you pay them off through debt consolidation. Remember, older accounts help to build your credit score. 

However, there are also ways debt consolidation can improve your credit score:

  • When you lower your revolving credit utilization rate: Your credit utilization rate is the amount of revolving debt — such as credit card debt — you have relative to your total available balance. The lower this is, the better. Paying off credit card debt with a fixed-term loan may increase your credit score because the credit utilization ratio falls.

  • When you consistently pay your debt on time: No matter what path you take for debt consolidation, if you make consistent on-time payments, it’ll positively impact your payment history and boost your FICO credit score.

Is debt consolidation right for you?

Debt consolidation is an excellent way to pay off high-interest debt, allowing you to save cash on interest and get out of debt quicker. However, there are several debt consolidation options available, including a debt consolidation loan, balance transfer credit card and a personal line of credit. 

Finding the right option for you depends on your specific credit situation and debt types. The sooner you determine which path is best for you, the more money you can save in interest.

If you have credit card debt you’d like to manage with a personal line of credit, the Tally†credit card debt repayment app can help. The app helps you manage your credit card payments — and Tally offers a lower-interest line of credit, allowing you to efficiently pay off higher-interest credit cards. 

To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) will be between 7.90% and 29.99% per year and will be based on your credit history. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 to $300.