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Is Debt Consolidation a Good Idea? What You Need to Know.

Apr 1, 2024 2 min read

Managing your personal finances can be overwhelming 鈥 when you鈥檙e tracking multiple credit cards, loans and payments each month, it can feel daunting to stay on top of everything, pay all of your bills on time and make sure you鈥檙e making smart decisions.

You might be considering debt consolidation as an option to help meet financial obligations when you鈥檙e having trouble paying all your bills. It鈥檚 important to weigh the pros and cons of debt consolidation and understand how it works, exactly, so you can decide if it鈥檚 the right choice for you.

What Is Debt Consolidation?

Debt consolidation is the process of combining all debts you owe 鈥 typically high-interest credit cards, and personal loans 鈥 and paying them off, either through a low-interest loan or a balance transfer credit card. 

When you consolidate debt, you only have one loan or credit card to pay every month. Debt consolidation can usually lower your interest rate and your total monthly payment.

How Does Debt Consolidation Work?

There are many ways to consolidate your debt. The two most common are balance-transfer credit cards and fixed-rate debt consolidation loans.

Balance-Transfer Credit Card

With this method, you open a new low-interest credit card and transfer all of your other credit card and loan balances onto it. Ideally, you鈥檒l transfer balances where you鈥檙e paying higher interest, so you鈥檒l lower the amount of interest you pay. Be sure to read the fine print so you understand transfer fees, annual fees and longer-term interest fees if you are choosing a balance-transfer card. 

Fixed-Rate Debt Consolidation Loan

With this method, you take out a fixed-rate loan and use the proceeds to pay off all of your other debts. According to , if your credit score is 740 or higher, you likely qualify for the lowest interest rates, making this a good option. 

You may still qualify for competitive, but higher, interest rates if your credit score is 670 to 739. If your credit score is below 670, debt consolidation might not make sense for you.

You can also consolidate debt through methods like a home equity loan or a 401(k) loan, but most experts advise against it. A home equity loan is backed by the value of your home. So, if you can鈥檛 keep up with the payments, you could risk losing it.

And when you use a 401(k) loan, you鈥檙e borrowing against the money that you鈥檝e planned to use for retirement. This typically includes taxes and fees. More importantly, it鈥檚 not growing for you, so you鈥檙e taking a chance you won鈥檛 have the money you need when you鈥檙e ready to stop working. 

Does Debt Consolidation Hurt Your Credit?

Debt consolidation might ding your credit score in the short term. That鈥檚 because when a lender checks your credit score to see if you qualify for a loan or credit card, it鈥檚 considered a hard inquiry and can lower your score by about 10 points for one year.

And the average age of your accounts impacts your credit score. So, if you consolidate your debt and then close your accounts, your average age will be lower, and your credit score may go down. If you know you won鈥檛 run up the balances again, you may want to keep the accounts open to help keep your credit score higher.

However, if you鈥檝e been having trouble making all of your payments on time, consolidating your debt with a lower monthly payment might help. A history of on-time payments will increase your credit score. 

Should I Consolidate My Debt?

Everyone鈥檚 financial situation is different. To decide if consolidation is a good idea, make a list of your credit cards and loans and their balances, interest rates and monthly payments. That way, you鈥檒l know how much you need to borrow and what interest rates and monthly payments might be right for you.

With that information, you can research rates and terms on credit cards and loans to determine if debt consolidation is right for you.

Get Financial Planning Tips 

Whether you鈥檙e looking to consolidate debt, save for college or invest for retirement, managing your finances can be tricky. A Farm Bureau financial advisor can help you work toward your goals. Reach out and schedule a consultation today.

Want to learn more?

Contact a local FBFS agent or advisor for answers personalized to you.