What Is Debt Consolidation?

What is Debt Consolidation?

Debt, especially credit card debt, is familiar to most Americans. According to a 2017 study by credit reporting agency Experian, the average American has 3.1 credit cards and $6,354 in credit card debt. While that isn’t a problem in itself, once you start carrying a balance on multiple cards, it can be difficult to manage and track the debt — especially when it needs to be repaid to different creditors at different times. Even when you have the best intentions, formerly manageable expenses can begin to mount.

There is a solution: debt consolidation. As its name implies, debt consolidation is the process of combining multiple debts into one.

How is this useful? First, there’s the appeal of simplicity. For some, it may make sense to combine certain debts, such as high-interest credit card balances, and roll them into one loan with a single monthly payment. This way, instead of having numerous payments, you could have just one recurring monthly payment.

Second, there could also be some savings. By consolidating your debt with a personal loan, you could have more favorable terms, such as a fixed rate. Rates on a personal loan may be lower than those on your credit cards or other forms of debt. With lower rates, you could save on interest.

How does debt consolidation work?

A common way to consolidate debt is to take out a personal loan. To do this, you can apply for a personal loan and use the amount you receive to pay off your existing debts. Then, you pay off the personal loan through monthly payments. Consolidation is also possible through other means such as a balance transfer credit card or home equity line of credit (HELOC).

Let’s look at an example. Say you’ve accumulated some debt thanks to a cross-country move to a new house. As a result, you now have $15,000 in credit card debt spread across two credit cards, both with an interest rate of 16.99%. You can pay off the credit cards one by one (some common ways of tackling debt include paying off the credit card with the lowest balance first or paying off the card with the highest interest rate first). Or you can consolidate all your debt and pay it off through predictable, monthly payments over a specified period.

Let’s say that, in order to pay off $15,000 of credit card debt with a 16.99% interest rate, you take out a personal loan from Marcus by Goldman Sachs with an interest rate of 12.99% and a 48-month term to pay it off. By consolidating all your debt with this personal loan with an interest rate that’s lower than the one on your credit cards (12.99% versus 16.99%), even when you make equal monthly payments, you could save as much as $2,305.54 in interest. What’s more, you would pay off the loan 6 months earlier than the credit card. Learn more with our Marcus personal loan calculator.

The beauty of consolidating your debt with a personal loan is predictability. Credit card interest rates generally vary with the market, but that’s not an issue if you have a fixed-rate personal loan. Assuming you make all your monthly payments on time, you’ll know that the debt will be paid off in full by the end of the term.

With this calculator, you can estimate how much you might save by consolidating your credit card debt through a Marcus personal loan.

Debt consolidation vs. debt settlement or debt management 

If you are really struggling and have fallen behind with payments, there are other options. One is going to a debt settlement company. Also called “debt relief” or “debt adjusting” companies, these companies promise to renegotiate or reduce the amount you owe to a creditor or debt collector. Debt settlement companies may charge high fees and some creditors may refuse to work with certain debt settlement companies. Also, these programs often encourage you to stop sending payments directly to creditors, which could have a negative impact on your credit score and limit your ability to get credit in the future.

Because of the risks, debt settlement companies are seen as a last resort option.

A debt management plan is another possible solution. Debt management plans are generally offered by nonprofit credit counseling agencies. The cost of using a debt management plans varies but agencies usually charge a fee of between $25 and $50 a month for three or four years, which must be paid in addition to the cost of paying back debt. When you start on a plan, you write a check every month to the credit counseling agency, which pays your creditors. The agency could help you negotiate lower interest rates or other, better terms. Your credit score will not be directly affected by the fact that you are enrolled in a plan, but while enrolled you have to close your credit card accounts and your access to new credit will be limited until your debts are paid off.

Because of the potential negative impact to your credit score and credit history, debt settlement and debt management plans are generally last-resort options.

When to consider debt consolidation 

Maybe you’re someone who only has a few debts here and there and, with a well-crafted budget, can tackle your debts. But, if you’re someone with numerous outstanding higher-interest debts, debt consolidation with a personal loan could be right for you.

If you do apply for a loan to consolidate your debt, be sure to check the agreement before signing, so you can avoid surprises. Verify the fees, charges and default terms. With Marcus loans, you don’t pay fees. That means when you take out a loan with us, the only thing you pay is your principal and interest.

With that in mind, here are some pointers for tackling your debt.

Don't: Pay debt and credit card balances without an overarching strategy.

Do: Prioritize your payments. The more strategic you are with payments, the faster your progress will be.

The good news: You can save money by paying off balances with the highest interest rates first. Another approach is to transfer your high-interest credit card debt to a lower-interest loan or to one credit card with a lower interest rate.

Don't: Forget about the cost of interest.

Do: Keep track of your interest rates. Credit cards can be a great way to make new purchases, but interest rates on those cards can add up quickly if you start accumulating balances. Moreover, the interest rate on most credit cards is variable, meaning it changes with the market.

The good news: If you know exactly what APRs you're carrying in your wallet, you can be smart about your purchases — and where you're accumulating new debt.

Don't: Think about each debt individually. 

Do: Get a clear picture of everything you owe. It is an important step toward eliminating your debts. By carrying various balances with differing interest rates and perks, it’s easy to get lost. But once you take the time to see everything you owe, you can start to make informed decisions and pay down your debt quicker.

The good news: By getting a clear account of your outstanding balances and their interest rates, you can be more purposeful about the way you manage your debt. And you could save yourself both money and headaches by getting organized.

The takeaway: don't wait to get your finances in order

Paying off your debt can be complicated. But the longer you wait to consolidate your debt, the more money you spend on paying off the accumulating interest. By assessing your outstanding balances, budget and consolidation options, you can develop a repayment plan that minimizes interest costs and gets rid of debt faster.

See how Marcus could help

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Wondering how to consolidate your debt from multiple creditors into a single monthly payment? One way is to transfer your debts onto a balance-transfer credit card, allowing you to take advantage of a low-interest promotional period to pay off the balance before the interest rate increases. Another option is to use a debt consolidation loan, which allows you to replace debt across multiple creditors with a single, personal loan that is then paid off in installments over time. In either case, you’ll still have debt, but it will be organized into one monthly bill. Sometimes a little reorganization goes a long way.

This article is for informational purposes only and is not a substitute for individualized professional advice. Articles on this site were commissioned and approved by Marcus by Goldman Sachs®, but may not reflect the institutional opinions of Goldman Sachs Group, Inc., Goldman Sachs Bank USA or any of their affiliates, subsidiaries or divisions.