Should You Consolidate Your Debt?

Dear Carrie,

With five credit cards, student loans, a car loan, and a few other debts, I feel overwhelmed. I’m current with everything and have okay credit, but just keeping track of all the payments is a hassle and constantly stresses me out. Most of my debts are already on auto-payment, but I’d like to consolidate my debt to make things more manageable. Is this a good idea?

—A Reader

Dear Reader,

Borrowing money is pretty easy. Paying it back is the hard part. And yes, handling multiple payment amounts and repayment schedules is stressful. It's one of the hidden “costs” of borrowing that affects millions of Americans.  

Debt consolidation could help you manage by streamlining payments and simplifying accounting. That may reduce your stress—but it won't reduce your debt. You're still on the hook for the money you borrowed. That's not to say consolidating isn't a good idea. But before you do, there are few things to consider.

Try these pre-consolidation moves

Managing current debt is one thing, making sure you don't take on more debt is equally important. So first, take a step back and look at how your expenses compare to your income. Are you overspending? If so, try to reprioritize and make changes in your budget before consolidating.

If it's just a question of monthly management, there are a few things you could do on your own. For instance, try reaching out to your creditors. You may be able to negotiate lower interest rates or change payment due dates which would help you feel more in control.

Talking to a credit counselor could help you put your debt in perspective and come up with managing techniques.

If you choose to consolidate, look beyond the monthly payment

Consolidating is taking out a single loan to pay off multiple loans. On the plus side, this means a single payment at possibly a lower interest rate with a corresponding lower monthly obligation. This may give you more breathing room short-term—but it could also extend your pay-off date, increasing the interest you pay over the life of the loan. So look at the big picture. 

The terms of a consolidation loan are important and depend on several factors, including your credit score, whether the debt is secured, how much you're borrowing, and current interest rates. Then there are things like balance transfer fees, closing costs and total interest paid. These can actually add to your debt.

Simplifying your finances and freeing up some monthly cash may be a worthwhile trade-off. On the other hand, the total cost over time might not be worth it. Be sure to shop around for the best possible deal.

Carefully weigh your consolidation options

There are a few different ways to roll all your debts into one. But like anything else, there are pros and cons to each and the choice for you depends on your timeframe and the risk you're willing to take.

• Balance transfer credit card—The simplest approach for credit card debt is transferring multiple balances to a single, low-interest card. The upside is you have one payment; the downside is that there are often balance transfer fees and possibly an annual fee.
• Unsecured personal loan—Offered by banks, credit unions and online lenders, there's no collateral required for this type of loan. Your creditworthiness is key to getting the best terms. Interest rates are usually fixed and repayment terms may be flexible. But look out for origination fees and prepayment penalties.
• 401(k) loan—Since there are no credit checks, and interest rates are generally low, a 401(k) loan can make sense in certain circumstances. But it's not a no-risk, no-cost option. First, you're borrowing against your retirement. Plus you risk incurring taxes and penalties if you don’t make timely payments. Finally, if you leave your job, you may have to pay back the loan in full in a very short time.
• Home equity line of credit (HELOC)—Low interest rates can make this an attractive option for homeowners. However, interest on HELOCs used to pay off debt is no longer tax deductible. Plus, refinancing unsecured debt like credit card balances with a secured home equity loan has inherent risks. If you’re late on making required payments, you could lose your home.

​​​​​Watch out for debt settlement scams

People with debt make prime targets for scammers—so beware of debt relief and credit repair offers, especially those offering debt forgiveness or settlement. These programs are different from loan consolidation and are often scams.  A big tip off is if you're asked for money upfront.

Typically, a debt settlement company recommends you stop debt payments and instead pay money upfront into a special account, which will be used to attempt to negotiate with your creditors. The catch is that while you may think reaching an agreement with a debt settlement company lets you off the hook if you miss a payment, interest, fees and penalties can still be added to the principal. Plus, you run the risk that creditors will hire debt collection agencies.  

On top of that, missed payments will show up as a negative transaction on your credit report, making it harder to get credit in the future. Even if a creditor agrees to accept less than the full amount owed, it will still impact your credit score.

Take special care with student loans

Consolidating student loans raises a whole different set of issues. And having multiple student loans, both federal and private, makes consolidation more complex. Take special care here.

For instance, federal direct consolidation loans are only available for federal student loans. They won’t necessarily lower your interest but can make payments easier with fixed rates and longer payback periods. 

On the other hand, private consolidation loans may offer lower interest rates (fixed or adjustable), but don't have the same protections as federal loans, such as income-based repayments, forbearance and forgiveness. The loan may also include additional fees and costs. And once you refinance federal loans into a private loan, you can’t turn them back into a federal student loan to get the federal program benefits.

Manage for both the short and long term

As you focus on managing your debt, also look at your bigger financial picture—your budget, goals and plans to reach them. Loan consolidation could help you get a better handle on your debt now, but make sure you're also thinking about the long term—which hopefully includes controlling debt in the future.

Have a personal finance question? Email us at askcarrie@schwab.com. Carrie cannot respond to questions directly, but your topic may be considered for a future article. For Schwab account questions and general inquiries, contact Schwab.