Each debt consolidation instrument is specific to a certain financial situation, and multiple variables should be considered before deciding on the best option. Pick the wrong one and you are paying thousands more in interest and other costs. Pick the right one and you are debt free sooner than expected.

What is debt consolidation?

Debt consolidation is an act of merging several debts into one. A common reason for debt consolidation is convenience. It is easier to manage one debt and to make one monthly payment instead of many. Another, much better reason, is favorable terms. Consolidation makes the most sense when the new debt is either cheaper or has a more manageable schedule.

Though multiple ways to consolidate debt exist, they may be broadly grouped into two distinct types. The first, the conventional type, is when you take out a new loan to repay multiple existing loans (in effect, merging them). The other type is not really debt consolidation, but is so often advertised as consolidation that we feel obliged to include it here. It’s when you hire an agency to manage your loans. You make a single monthly payment to that agency and they distribute the money among your creditors. The experience is similar to debt consolidation, but your debts remain separate.

Specific debt consolidation instruments include credit card balance transfers, both secured and unsecured personal loans, debt management plans, and debt settlements. The two latter ones are of the “fake” kind we described above. Which instrument to use depends on your specific situation, debt type and size, credit score, and a number of additional factors.

Debt consolidation instruments vary both in approach and quality, as do the first-hand experiences of people who use them. That’s why some think consolidation is a grand idea while others believe it’s a scam. In truth, some consolidation instruments, especially settlement services, are a lot like scams. They might hide costs, change terms on the go, forget to mention risks, or promise an overly optimistic outcome. That’s why consolidation decisions shouldn’t be taken lightly. Educate yourself, research your options, weigh them against your specific requirements, and you just might come out on top.

Credit card balance transfer

A balance transfer is a consolidation instrument that is used mainly for credit card debt. Here is how it works. You open a regular credit card or a designated balance transfer card, or request a balance transfer to an existing card. Once approved, you transfer various smaller balances from your other credit cards to this one card. That’s it: you’ve effectively merged your debt by using one card to pay off multiple other cards.

The main reason to use a balance transfer is if the new card offers a meaningful incentive. Designated balance transfer cards, for example, offer a 0% interest rate for a fixed period of time, called the promotional period. Such incentives are usually offset by additional costs, so it’s all down to math and whether it works out in your favor.

Who qualifies for a balance transfer credit card?

Balance transfer is one of the tricks banks use to lure clients away from their competitors. They find a client at a competitor bank, someone who has lots of credit card debt, and they offer to move all this debt to their bank—on attractive terms. But—and here is the catch—they are only interested in good clients, people who pose little risk in terms of paying this debt. That’s why they want you to have a high credit score and a low debt-to-income ratio.

What are the costs of a balance transfer?

The transfer fee is the immediate cost of this instrument. It ranges between 3% and 5% of the transfer amount, though some cards offer free transfers. The fee is not paid upfront. Instead, the amount is added to your new balance and becomes a part of your debt. Do pay attention to whether or not the fee is a subject to promotional interest rates. Because if not, you’ll be charged full interest on this amount until the entire balance is paid off.


Let’s say you are transferring $10,000 of credit card debt, with a promotional period of 24 months and a transfer fee of 5%. However, the promotional interest rate does not apply to the transfer fee. The non-promotional interest rate on that card is 20%.

Once the transfer is complete, your new balance is $10,500 (transfer + transfer fee). You are now charged interest on that $500. That interest is charged until you pay the entire balance. If you manage to pay your balance within the 24-month promotional period, you still accumulate over $200 of interest. The transfer fee is now up to $700 (fee + interest), or 7% of your initial balance. It might not sound like much, but with debt consolidation you are already trying to win by a very thin margin, and that fee could be a deal breaker.

The other cost to keep in mind is the annual fee. When the balance transfer card is used to make purchases, those purchases are not covered by the promotional interest rate. That’s why it’s not a good idea to use balance transfer cards for anything but paying the balance.

What are the risks of a balance transfer?

A balance transfer comes with a set of commitment challenges. While it feels like the pressure of debt has been lifted, the debt itself hasn’t gone anywhere. Devotion to making payments is now more important than ever. Breaking that commitment is going to be costly.

Abuse of newly available credit limits

Once the balance transfer is complete, you are left with a bunch of old credit cards that can be used again. It’s tempting. It’s where people fail. If you know by experience that you might be one of those people, it might be best to eliminate the risk by cutting your credit cards up. Otherwise, you have every chance of doubling your debt within a short time.

Violation of balance transfer terms

It might be hidden in small print, but balance transfer cards do not tolerate term violations. If you fail to meet minimum payment requirements, the promotional interest rate is going to revert to the regular one. It can’t be changed back after that. And another balance transfer is unlikely to be available to people who fail at balance transfers.

Failure to pay the balance off

A third of balance transfer users fail to pay the entire balance before the promotional period ends. After the promotion, the interest rate goes back to normal. And the “normal” interest rate on a balance transfer card tends to be higher than the “normal” interest rate on any other credit card.

Damage to credit score

Unless you are pre-approved, there is going to be a hard inquiry upon balance transfer application. It’s going to drop your score upwards of 10 points. Once approved, the average age of your accounts is going to take a hit from a newly opened card. And, in case you decide to cancel your old cards, your utilization will go up, negatively affecting your score. Long-term though, if your balance transfer strategy is a success, your credit score will eventually go up.

When to consider a balance transfer?

As we’ve mentioned earlier, a credit card balance transfer is restricted to people with excellent credit scores and low debt-to-income ratios. So, for starters, your credit score has to be above 700 and you have to have a fair share of disposable income in excess of your credit payments and other expenses. Next, the math should work out in your favor. Take the time to write down how much you lose and save on the balance transfer and see whether you come out on top. Finally, only consider a balance transfer when you are confident that most of that balance is going to be paid by the end of the promotional period.

Alternatively, there is a much simpler guide. If you “need” a balance transfer, then it’s the wrong instrument for you. It’s only right in case you are doing ok as it is, but might want to step it up a little.

  • Interest rate suspended for 6+ months;
  • Allowed amounts up to $15,000;
  • Debt moved to a single account.
  • Good credit history required;
  • Balance transfer fee;
  • Limited to credit card debt.

Personal loan

A personal loan is when you borrow money from a bank and use it to pay off multiple smaller ones. The key distinction of a personal loan is that, unlike credit card debt, it is a fixed amount that has to be paid out in equal monthly payments over a fixed period of time. There is no wiggle room; it’s like a Japanese train and it arrives on schedule. Another difference is that, unlike a balance transfer, it is not limited to credit cards and most types of debt may be consolidated with a personal loan.

As consolidation tools go, a personal loan is the most versatile in terms of its applications. It could be used to seek out better loan terms with the goal of paying less interest.

It could be used to lower monthly payments during the time of financial struggle. It is also the only tool that allows consolidating both installment and revolving debt. But, before we get overly excited, let’s take a detailed look at some of its trade-offs.

Who qualifies for a personal loan?

As with a balance transfer, a personal loan requires excellent financial standing. Generally, a bank would look at your credit score, which should be above 700, your debt-to-income ratio, which should be below 50%, and your overall credit history. Unlike with a balance transfer, there is no promotional interest rate and your actual interest is calculated upon application. The range is between 8% and 20% or higher, and depends on how low your debt-to-income ratio is.

What are the costs of a personal loan?

Personal loans do not have a transfer fee, but they do have an origination fee, which could be as high as 6% of the loan amount. You don’t have to pay the fee—it is subtracted from your loan.


If you were to borrow $10,000 with a 6% origination fee, the bank would keep $600 as a fee and give you the remaining $9,400. In this example, if you meant to borrow the entire amount of $10,000, you should have asked for $10,640 so as to be left with $10,000 after the fee of 6% is subtracted.

There is also such thing as a termination fee (aka exit fee, prepayment fee). When you want to pay the entire amount of an installment loan before it’s due, you might have to pay a termination fee. That’s how the bank makes up for the interest you’ve skipped by paying early. If you want to use a personal loan to close some of your other installment loans, check whether those installment loans have a termination fee.

What are the risks of a personal loan?

The single worst risk of a personal loan is not doing the math. Personal consolidation loans are advertised as a way to clean up credit card balances in exchange for a low monthly payment to the bank. The thing that many people don’t realize is that while the payment and the interest are low, the bank neglects to advertise the fact that the duration is so long that over time you end paying way more in interest fees.


Let’s say you have $1,000 of credit card debt at 15% and $100 monthly payments. The bank offers to turn it into a personal loan at 10% and $25 monthly payments. The interest rate is lower, and the payment is lower as well. Great deal, right? Well, at this rate, it will take four years, instead of one, to pay the entire balance and it will cost over $200 in interest, instead of the $100 it would have cost otherwise. And don’t forget to add the origination fee to your total loss.

When to consider a personal loan?

Since personal loans can perform a variety of functions, it’s best we look at its applications case by case. Keep in mind, however, that two things are universal across personal loan applicants: they have to be in good financial standing and the math should check out.

Better terms

The best justification for a personal loan consolidation is when the terms allow you to pay less interest. This is only possible when the monthly payments are either the same or higher than your current payments, but the interest rate is lower. When the bank offers lower monthly payments, however, it will definitely be compensated with a longer duration and more interest accumulated over time.

Better schedule

Another case is when you are actually willing to take on a longer schedule and resulting higher interest fees in exchange for lower monthly payments. This option would be appealing to people struggling with minimum payments on their other debts and risking penalties and additional costs.

Commitment, convenience, and credit score

Sometimes the math barely works out, but the convenience of a single payment and the certainty of a fixed schedule make a compelling case. Another benefit of converting credit card debt to an installment loan is credit score growth, which results from lower utilization and higher credit diversity.

  • Interest lower than for credit cards;
  • Allowed amounts up to $50,000;
  • Suitable for installment and revolving debts;
  • Credit score positively impacted;
  • Debt moved to a single account.
  • Interest lower than for credit cards;
  • Allowed amounts up to $50,000;
  • Suitable for installment and revolving debts;
  • Credit score positively impacted;
  • Debt moved to a single account.

Secured/co-signed personal loan

For people in poor financial standing, a regular personal loan either comes with a very high interest rate or is not available at all. That’s why we have a secured personal loan. It’s much easier to qualify for because you offer some kind of collateral as an insurance against non-payment. It’s common to borrow against a house, less common to borrow against a car or other property. When no property is available, you can ask someone in better financial standing than yours to co-sign a loan, which means they will be responsible for paying it in case you fail.

How is a secured loan different from a regular one?

Well, the collateral, obviously. But there is also a couple of additional characteristics that should be considered.

Low interest rate

A secured loan doesn’t only let you into the game—it does so at a lower cost. A secured loan is, on average, between 5% and 8% cheaper than a similar unsecured loan.

It’s the last resort, almost

If you fail to pay a secured loan, you are out of tricks and your property will be collected. Your only hope in that case is to file for Chapter 13 bankruptcy, which might help when negotiating with your creditors and save your property through a more manageable payment schedule. And through that process, you will be relieved of every spare penny.

When to consider a secured loan?

There is no downside to a secured personal loan when you are 100% certain that it will be paid on schedule. The rates are low and the interest is tax deductible. It’s a good deal all around. If you are not 100% certain, however, you should only consider a secured loan when no other option is available.

  • Poor credit history accepted;
  • Interest lower than for regular loans;
  • Allowed amounts up to $100,000;
  • Suitable for installment and revolving debts;
  • Credit score increases;
  • Debt moved to a single account.
  • Risk of property loss;
  • Origination fee;
  • Tricky math;
  • Risk of amassing new debt.

Debt management program

The essence of a debt management program is that you hire a credit counseling agency to help you get out of debt. Their services include personal finance classes, payment planning, and negotiating with your creditors. What makes this seem like debt consolidation is that the agency takes care of your payments as well. You make a single payment to the agency and it distributes the money among your creditors. The payments are consolidated, which, from your perspective, is the same as having your debt consolidated.

What are the costs of a debt management program?

Credit counseling agencies are non-profit organizations that take minimal fees just to keep the lights on. The initial meeting is free. Beyond that, you pay a registration fee of about $75 and a monthly fee of between $10 and $25 per credit account added.

When to consider a debt management program?

We’d say that a debt counseling agency is the first line of defense. They organize your debt in a better way, without moving it anywhere. There are some costs, but no risks and you keep the other, more radical options, open. And it does a good job imitating debt consolidation since your payments are down to one and your terms might get better due to agency negotiations. Seems like a good deal all around, and we recommend everyone try it before moving onto balance transfers and personal loans.

  • No entry requirements;
  • Negotiate on your behalf;
  • Effect similar to consolidation;
  • Added element of accountability.
  • Registration and monthly fees

Debt settlement

Debt settlement is achieved through the deliberate non-payment of debt until the creditor panics and agrees to close the account if you pay at least a part of what you owe. To set this in motion, you’d normally hire a specialized agency and they would tell you to stop payments on your debts. Instead, you send the money to them and they put it in a separate account. After about a year, just when your creditor gets nervous, they would attempt a settlement with the money accumulated from diverted payments. Normally, the agency manages to settle for about 70% of what you owe.

What are the costs of a debt settlement?

Debt settlement agencies are for-profit companies and a bit ruthless at that. They charge a percentage of either the amount of debt or the amount they’ve managed to save. In either case, it’s likely to be about a third of the forgiven amount. The forgiven amount is also taxed as income. On top of that, during the period of diverted payments, you suffer late payment penalties on your account. Penalties may come in the form of a fee or an increased interest rate or both.


Let’s say you have a $10,000 account with a 15% interest rate and you want to settle. You hire an agency and divert your payments for a year. During that year, you incur 12 late payments, $35 per month—that’s $420. Additionally, after several months of missed payments, your interest rate is up to 30%. At the end of the year, your account is roughly $13,000. The agency manages to settle it at 70% ($9,000). Your “gain” is $4,000.

The agency charges 25% of the forgiven $4,000—that’s $1,000. That forgiven amount of $4,000 is also taxable as income, let’s assume at a 25% tax rate. That’s another $1,000. Your “gain” is down to $2,000. But, relative to the initial amount, you have a loss of $1,000 since, taxes and fees included, you’ve paid $11,000 to close a $10,000 account.

If you were to make your payments directly to the bank, you would suffer no penalties and, after a year, pay $10,800 to close that same account, ending up $200 ahead of the settlement agency.

The agency could have managed to settle for 50% or persuaded the creditor not to include the interest and late fees and, in that case, the use of the agency would have been justified, but those cases are rare.

What are the risks of a debt settlement?

Apart from the financial considerations we have outlined above, debt settlement is not always successful. The statistics are varying, but some sources say that as much as 80% of accounts are never settled. Just imagine wasting a year in hopes of a settlement, failing, and being left not only with your original debt, but with all those penalties that arose over that time. Not a pretty picture. Also,, your credit score is ruined regardless of whether you are successful or not, because using settlement is not something creditors look for in a client.

When to consider a debt settlement?

Do not consider a debt settlement. Using any other instrument—even using no instrument—is better than using debt settlement.

  • Negotiate on your behalf;
  • Sometimes manage a big win
  • Not always successful;
  • Agency fees;
  • Penalties on unpaid account;
  • Taxable as income;
  • Damage to credit score.

The bottom line

Selecting a consolidation instrument depends on your specific situation and even your personality. The most gain is achieved through balance transfer credit cards, as nothing beats the absence of an interest rate. At the same time, a balance transfer requires discipline and a strong will to make the most of the promotional period while restraining yourself from creating new debt. Then there is a debt management program, which helps you to maintain commitment, but doesn’t necessarily provide much financial gain. Personal loans sit somewhere in between, and it’s only right when the math works out (more so than for any other instrument).

In the end, the choice is up to you. All we ask is that you stay vigilant and do not make any decisions until all the variables are taken into account.