What is Debt Consolidation?

Find out everything you need to know about debt consolidation in this guide. Inform yourself before you make any financial decisions.

Debt consolidation is when you combine multiple debts into one single loan. It can make it easier to manage payments and sometimes reduce the overall interest you pay.

Debt consolidation loan meaning

A debt consolidation loan is a type of loan that combines multiple debts, such as credit card balances or other loans, into a single loan. This can simplify your payments and potentially lower your overall interest rate, making it easier to manage your debt.

If you’re looking to consolidate your existing debt, follow these steps.

1. Assessment

Evaluate your current debts, including credit card balances, personal loans, or other outstanding obligations.

2. Research and comparison

Research and compare consolidation loan options from various lenders, such as banks, credit unions, and online lenders. Look for favourable interest rates, fees, and repayment terms. If you secure a lower interest rate on the consolidation loan compared to your previous debts, you may save money over time.

3. Application

Apply for a loan with the chosen lender. The lender will assess your creditworthiness, income, and other factors to determine if you qualify for the loan.

4. Loan approval

If approved, you receive a loan with a fixed amount that covers the total of your existing debts.

5. Repayment

Use the consolidation loan to pay off your existing debts. Now, you have only one loan payment to focus on. Make regular payments to repay the consolidation loan. This payment is often lower than the combined payments of your previous debts, making it more manageable.

6. Financial discipline

Debt consolidation requires discipline to avoid taking on new debts while paying off the consolidated loan.

Personal loan

While similar to a debt consolidation loan, a lower-interest personal loan can be used to pay off high-interest debts. This has the extra benefit of not being limited to consolidating debt; you can also use the money for other expenses.

Credit card balance transfer

If your credit is good, you might be eligible for a balance transfer credit card with a low or 0% introductory interest rate. You can transfer high-interest debt onto this card and work to pay it off during the promotional period.

Debt snowball/debt avalanche

With the debt snowball method, you focus on paying off the smallest debts first, while with the debt avalanche method, you prioritise debts with the highest interest rates. As you pay off each debt, you use the money you were paying toward it to tackle the next debt.

Home equity line of credit (HELOC)

If you own a home, you might consider a HELOC, which uses your home’s equity as collateral. This can offer a lower interest rate, but it also comes with the risk of potentially losing your home if you can’t make payments.

Debt consolidation vs personal loan

A consolidation loan is specifically used to combine multiple existing debts into one loan. A personal loan, on the other hand, is a more general type of loan that you can use for various purposes, including consolidating debt, going on holiday, car repairs or other emergency expenses, without the requirement to merge existing debts.

Debt consolidation loan vs balance transfer

A debt consolidation loan is a new loan that combines multiple existing debts. A balance transfer is when you move existing credit card balances to a new card with a low or 0% introductory interest rate. Both can be helpful ways to reduce debt.
In general though, if you have multiple types of debts beyond credit cards, a debt consolidation loan might be more suitable. However, if you have significant credit card debt, a balance transfer could provide short-term interest savings.

Debt consolidation vs debt snowball method

While debt consolidation means combining multiple debts into one new loan, the debt snowball method involves paying off debts one by one, starting with the smallest.
If you prefer a structured approach and want to address multiple types of debts, consolidation could be a good fit. If you want a motivational strategy and have debts with varying balances, the snowball method might suit you.

Debt consolidation loan vs home equity line of credit (HELOC)

While a debt consolidation loan is a brand-new loan used to combine multiple debts, a HELOC is a type of loan that uses your home as collateral. If you have significant equity in your home and need a larger amount of funds, a HELOC might be suitable. If you prefer a loan not tied to your home or have lower equity, a debt consolidation loan could be a better choice.

Whether or not debt consolidation, as opposed to another method of debt management, is a good or bad idea for you will depend on your particular circumstances.
Carefully consider the risks and benefits of each approach before making a decision. You can contact the team at Red Tree Finance for more information, or apply for a small online loan if you’d like to give consolidation a go.