How Debt Consolidation Loans Work

If you have ever done any sort of loan search, specifically student loans, you have probably come across the phrase “consolidation loan.” If you have multiple credit cards, you have probably seen offers to consolidate on one card. These loans are often a good idea, but you should know how the work and what they do before you jump in.

Consolidation loans are essentially a new loan that pays off multiple old loans. Rather than having, for example, two student loans with different lenders for $5,000 each, you could have one $10,000 loan. That means one payment instead of two. That means one company to deal with instead of two. You can do a consolidation loan at either lender you are with originally, or you can pick a new one if you can get better terms.

There is always a however, though. If you have two Federal student loans at 6.8% and your consolidation offer is for 7%, you should keep the loans where they are. If the interest rates are the exact same, you should probably stay where you are. Consolidation loans have the same set of origination fees as any new loan. Unless interest rates are going to be lower for a long enough time to save you money over the fees, it is probably best to endure the headache of multiple lenders. Alternatively, if you have the cash, you could just pay one (or both) of the loans off early and make no payments and pay no interest.

The same is true for credit cards. Balance transfer offers often come with fees. There may be a temporary no interest period, but the interest rate eventually goes up. Unless you are transferring the balance to a card with a lower interest rate, you should not do it.

To summarize the pros of debt consolidation:

Fewer payments
Fewer lenders
Less hassle

And the cons:

New fees
Possible higher interest rates
Your new lender might be an asshole

If you are moving around debt balances, you should be careful, educated, and calculated. Treat your loans like you treat your cash. You are not going to move your bank accounts to a company that charges fees and pays you less interest. You are not going to pick some sketchy guy on the street to trust your money with. Loans should be the same, they have a long lasting impact on you and your credit. Be smart and consolidate, if it is the right thing to do.