Debt Consolidation

You may be able to lower your cost of credit by consolidating your debt through a second mortgage or a home equity line of credit. But these loans require you to put up your home as collateral. If you can’t make the payments — or if your payments are late — you could lose your home.


What’s more, consolidation loans have costs. In addition to interest, you may have to pay "points," with one point equal to one percent of the amount you borrow. Still, these loans may provide certain tax advantages that are not available with other kinds of credit.

Learn about the advantages and disadvantages of debt consolidation for dealing with debts.

In these challenging economic times, debt consolidation and bankruptcy are popular debt management strategies. Is debt consolidation or bankruptcy right for you? To find out, learn about the advantages and disadvantages of each approach.

(To learn about other ways to deal with debt, visit our Debt Management topic area.)

Debt Consolidation

Proponents of debt consolidation often promote this strategy as a simple way to save money and protect your credit rating. When you consolidate your debts, you reorganize multiple debt payments into one payment. You can choose to consolidate debt through a secured loan or an unsecured loan. (To learn more about the types of debt consolidation, visit Nolo’s Debt Consolidation topic area.)

Pros of Debt Consolidation

Here are some of the advantages of using debt consolidation to better manage your debt.

Protect your reputation and credit rating. Unlike bankruptcy, debt consolidation is not a matter of public record. Anyone who looks hard enough will find out about your bankruptcy. Bankruptcy records are viewable through an electronic subscription service called PACER or at any federal bankruptcy courthouse. Although a debt consolidation loan may show up on your credit report, it does not typically lower a credit score like a bankruptcy filing does.

Maintain your access to credit. Unless prohibited by the debt consolidation agreement, you can keep your credit cards. This may be helpful should an emergency arise. However, if you already owe a significant amount of money or are in default, you may not be able to use your credit cards or be approved for additional credit. Also, continued credit card use may defeat the purpose of debt consolidation.

Simplify your debt management. When you consolidate your debt, you no longer have to keep up with multiple payments, at different interest rates, to various creditors. Instead, you make one convenient payment.

Lower interest rate and monthly payment. If you consolidate your debts, you may be able to obtain a more manageable monthly payment, with a lower interest rate. As a result, you will have more cash available each month to meet your high priority needs.

Cons of Debt Consolidation

Although there are some advantages to debt consolidation, it’s not an option to take lightly. You could end up costing you money in hidden fees and tax liability. And more important – you could lose property.

You could lose your property. If you use property such as your home or vehicle as collateral for the debt consolidation loan, you could lose that property if you default on the loan payments.

Also, if a lender gives you a debt consolidation loan, there may be a cross-collateralization clause that allows that lender to take other property it has financed if you default on the debt consolidation loan. For example, let’s say that you have a car loan through your credit union and then the credit union gives you a debt consolidation loan. Under the cross-collateralization clause, if you default on the debt consolidation loan, the credit union could repossess your car – even if the car payments are current. (Learn more about cross-collateralization.)

Beware of hidden costs. Although lower interest rates and monthly payments are appealing, a debt consolidation loan could end up costing you more money. Often, debt consolidation loans help you achieve a lower monthly payment and interest rate in exchange for extending the repayment period. If you stay in debt longer, you may end up paying more over the long term.

Negative tax consequences. Depending on your financial condition, any money you save from debt relief services such as debt consolidation may be considered income by the IRS, which means you pay taxes on it. Credit card companies and other creditors may report settled debt to the IRS, which the IRS considers income.