Our top picks of timely offers from our partners

More details
National Debt Relief
Learn More
Terms Apply
National Debt Relief helps consumers with over $10,000 of unsecured debt and has operated since 2009
UFB Savings
Learn More
Terms Apply
Up to 5.25% APY on one of our top picks for best savings accounts plus, no monthly fee
Freedom Debt Relief
Learn More
Terms Apply
Freedom Debt Relief can help clients get started without fees up front
LendingClub High-Yield Savings
Learn More
Terms Apply
Our top pick for best savings accounts for its strong APY and an ATM card with no ATM fees
Learn More
Terms Apply
Get paid early with direct deposit and pay no overdraft, transfer, or minimum balance fees
Select independently determines what we cover and recommend. We earn a commission from affiliate partners on many offers and links. Read more about Select on CNBC and on NBC News, and click here to read our full advertiser disclosure.

What is debt consolidation?

Select defines debt consolidation, how it works and why it can save you money in the long run.

Getty Images

Before the coronavirus pandemic, financial advisors typically recommended people prioritize debt payoff first and foremost. But following a spike in unemployment and now rising inflation, the focus has shifted to savings.

It is very important to have an emergency savings account. And while experts advise you stash anywhere from three to six months' worth of expenses in a high-yield savings account, having at least a $1,000 saved is a good place to start. But it's hard to know what goals to prioritize if you've got a lot of credit card debt and not much savings.

As long as you make your minimum payments on time, your credit score will stay in OK shape, and saving will help you be prepared for financial surprises ahead, such as getting laid off, losing revenue or being furloughed.

However, credit cards have the highest interest rates out of every kind of credit product. If you've recently decided to stop prioritizing paying off your lingering credit card balances so that you can pad your nest egg instead, you may end up paying a staggering amount in interest in the long run.

One solution is to use a personal loan through companies like SoFi, LightStream or Happy Money to consolidate your credit card debt into one monthly payment. This usually results in lower interest and can help you interrupt the debt cycle for good.

Below, Select explains what debt consolidation is, how it works and why it can save you money in the long run.

Subscribe to the Select Newsletter!

Our best selections in your inbox. Shopping recommendations that help upgrade your life, delivered weekly. Sign-up here.

What is debt consolidation

If you have outstanding debt on more than one credit card, you can apply for a debt consolidation loan. You use this loan to pay off your credit card debt, then repay the loan in monthly installments, usually with a lower interest rate than you were paying on your credit cards. Typically, personal loans are fixed-rate, meaning the APR is locked in for the lifetime of the loan, and you pay the same monthly amount until it's paid off. This is an advantage over credit cards, which have variable APRs that can go up and down.

You can get a loan through a traditional lender, like a bank, or from an online peer-to-peer lending company like SoFi or LendingClub. Banks tend to have traditional standards consumers must meet to get approved for a loan, meaning you will need to have a qualifying credit score, significant borrowing history with documented on-time payments and a high enough debt-to-income ratio that proves you have the resources to afford the monthly payment. On the other hand, peer-to-peer lenders have slightly more relaxed or non-traditional requirements. For example, Upstart looks at your level of education and job history in addition to your credit score.

How debt consolidation works

Debt consolidation loans are similar to a balance transfer card with a 0% APR period, but they work a little differently. To begin with, balance transfers typically charge fees between 2% and 5%, unless you opt for a no-fee balance transfer card. The Citi® Double Cash Card, for example, has an intro balance transfer fee of 3% of each transfer (minimum $5) completed within the first four months of account opening. After that, your fee will be 5% of each transfer (minimum $5; see rates and fees). The card requires good to excellent credit to qualify, whereas there are a variety of personal loan options for people with fair credit and good credit.

Unlike a balance transfer, where you move debt from one account to another, when you get a consolidation loan, the cash is deposited directly into your bank account that you can use to pay off all of your credit card debt at once. Then, you pay back your lender with monthly payments over a timeline that is determined when you apply for the loan. Once a personal loan is paid off, the credit line is closed and you have no more access to it. 

Like any loan, you'll be charged interest. But unlike credit card interest, which averages about 16.6% according to the Fed's most recent data, an APR for a personal loan can be as low as 4% (based on your creditworthiness). Typically, your interest payments are calculated into your monthly payment and divided over the lifetime of the loan. Most loan terms range anywhere from six months to seven years. The longer the term, the lower your monthly payments will be. However, you'll be charged more interest over time so it's best to elect for the shortest term loan you can afford.

In addition, some lenders charge a sign-up, or origination, fee. However, there are several no-fee options with varying interest rates depending on your credit score. You should opt for a no-fee personal loan whenever possible.

Debt consolidation loans are great if you have multiple credit card balances. Merging those balances into one personal debt consolidation loan is a helpful way to streamline your bill payments, since you'll only have one account to keep up with.

See if you're pre-approved for a personal loan offer.

The most important factor in debt consolidation loans

While debt-consolidation loans make budgeting easier, the most important factor to consider when opening one is the interest rate. Americans average $6,194 in credit card debt at the time of this writing, and the average APR is about 16.65%. Assuming you were to only make the minimum payment each month (on time, so you avoid paying late fees), it would take you more than 17 years to pay off this balance, and you'd pay an estimated $7,286 in interested fees. (Learn more about how we got these numbers.)

Meanwhile, with the flexibility of peer-to-peer lending platforms, you can score a debt-consolidation loan with APRs as low as 4%, give or take with the prime rate. The average APR for personal loans at the time of this writing according to the Fed is 8.73%.

For example, say you have $10,000 worth of credit card debt with a 16.65% APR. If you paid it off in three years, you would pay a total of $2,656.53 in interest, according to Experian's APR calculator. Meanwhile, if you took out a personal loan with 8.73% APR, you would pay $1,281.09 in interest. This is a potential savings of $1375.44 — you'd cut your interest payments by more than half.

Before applying for any kind of personal loan, you should see what APR you prequalify for using the loan company's website. This can usually be done by inputting your social security number, date of birth, annual income, employment status and contact information.

While it's not a guarantee, this will give you an idea of what rates you qualify for. If the lender offers you the same APR, or a higher rate, on the loan as your credit cards, you should not consolidate.

Bottom line

Debt consolidation loans can help you streamline your budget by letting you pay off debt in one simple monthly payment. Moving your credit card debt over to a personal installment loan will also usually cause a noticeable jump in your credit score, since this effectively brings down your credit utilization rate

However, despite the convenience and simplicity of a consolidation loan, you should pay close attention to interest rates and fees as you inquire about preapproval. Ideally, you can find a loan that can both helps make your monthly payment more manageable while also saving you on interest in the long-run.

And like any credit product, be sure that you have a plan in place once your balance hits $0 to help you keep credit creep at bay.

Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.
Rocket Mortgage
Learn More
Terms Apply
Rates could continue to rise - look into refinancing with one of our top picks.
Earn more with a high yield savings account
Learn More
Terms Apply
Fed rate hikes can mean higher rates on savings accounts