There's never a good time to have a lot of personal debt, but now would have to be one of the worst times.
Americans are increasingly relying on credit cards to make everyday purchases and pay bills. Credit-card balances surged 13% last quarter compared with the same quarter in 2021, the largest jump in more than 20 years, according to data from the New York Federal Reserve.
Since March, the Federal Reserve raised interest rates by a cumulative 225 basis points, or 2.25%. That's helped push average credit-card interest rates to nearly 18%, an all-time high since CreditCards.com began tracking it in 2007.
A similar trend is occurring with personal loans, mortgages and other forms of credit.
The high interest rates make credit-card and debt-consolidation programs attractive routes for consumers, said Bruce McClary, senior vice president of membership and communications at the National Foundation for Credit Counseling.
These programs often advertise lower interest rates to combine all your debt and repay it under one loan, but there's more beneath the surface.
What does debt consolidation mean?
Debt consolidation means taking out a new loan to pay off multiple types of debt. It could also be used to pay off debt you've incurred from multiple credit cards, also referred to as credit consolidation.
If approved, the lender will either directly deposit the money in your bank account with the expectation that you will use it to pay off the debts you're consolidating or the lender will pay the balances for you.
Importantly, that does not mean you're debt free. You'll be responsible for making a single, typically fixed-monthly payment to the lender.
Does debt consolidation hurt your credit score?
Debt consolidation doesn't inherently hurt your credit score.
But if you apply for a debt consolidation loan (or any kind of loan), the lender must run a "hard" credit inquiry, which is recorded on your credit report. If you have a good credit score, the inquiry should have a negligible impact on your score. But if you have a poor credit score or have had several recent hard credit inquiries, your credit score could temporarily drop by as much as 10 points.
It's important to research rates before submitting an application. McClary recommends comparing rates and terms at sites like NerdWallet or Bankrate. If you don't make your minimum payment on time, your credit score will drop.
Is it a good idea? Who qualifies for it?
The answer largely depends on an individual's credit score.
McClary said debt-consolidation ads will often say, "'you could get an interest rate as low as x,' but that interest rate may only be available to people with the best credit scores."
In general, you'll need a FICO credit score that's in the mid-600s, according to Bankrate. Along with credit scores, lenders also consider your income and other financial criteria.
Some lenders don't specify a minimum credit score, but if you have a credit score below 600, you're less likely to get approved. Or if you get approved, the interest rate the lender offers you will be higher than the advertised rate and they may not offer as large a loan as you need.
By contrast, if your FICO credit score is 670 or higher, consider applying for a signature loan – an unsecured personal loan which likely has a better interest rate, McClary said.
What are the disadvantages of consolidating?
Many lenders can offer borrowers low interest rates on debt-consolidation loans because they have lengthier terms. That could end up costing you more than if you didn't go the debt-consolidation route.
Debt-consolidation companies also may charge additional fees such as a one-time loan origination fee and force you to pay a higher interest rate if you don't opt for auto-paying.
"That extra cost over time on interest and fees could cut into your ability to build up your safety net or save for a secure retirement," McClary said. "So you don't want to sacrifice your future for the present."
Above all, debt consolidation isn't "a silver-bullet solution," said Ismat Mangla, executive director at MagnifyMoney, a site that gives personal finance advice. The site is owned by LendingTree, an online loan marketplace.
While debt consolidation may reduce some of your headaches now, if you don't change any of the financial habits that led you to pile on debt in the first place, you're only going to dig yourself a deeper hole, Mangla said.
She recommends contacting a nonprofit credit-counseling agency like NFCC to discuss whether it makes sense to consolidate your debt. They can also help you set up a debt-management plan where you make one monthly lump payment to the nonprofit that makes payments to your creditors for you. In some cases, they're also able to negotiate lower fees and interest rates.
You also can contact your creditors and seek a lower interest rate or terms that will make it easier to repay debt.
The savings you get may help you avoid the need for a debt-consolidation loan.