5 steps to successful debt consolidation: your path to the other side of debt

When you're ready to shed your debt and create a brighter financial future, debt consolidation could be a winning strategy. It could be a smart way to manage your finances. On the flip side, borrowing more when you’re already in debt could leave you spinning your wheels if you charge forward without a well-thought out plan. Let’s explore the ways to make sure a debt consolidation loan becomes an effective tool in your toolbelt. The goals are to streamline your debt, get a financial benefit, and polish up your budgeting and spending habits. 

If you can imagine the day when your debts are behind you, you’re ready to set yourself up for successful debt consolidation. 

Step 1: Do a financial inventory

A financial inventory tells you where you stand. 

• List all of your unsecured debts. Unsecured debts are things like credit cards, loans, and medical bills. Note the balance, interest rate, and minimum payment for each. You’ll ignore secured debts like mortgages and home equity loans because those aren’t candidates for consolidation. Car loans are secured but they’re a maybe. If the interest rate is high, your auto loan may be a candidate for consolidation.

• Calculate your total debt. Add up your unsecured debt balances. This is your starting point when you research loan options. If you can’t get a debt consolidation loan big enough to cover all your existing unsecured debt, you’ll need to prioritize and choose from your list.

• Check your credit score. Your credit score plays a role. Most lenders will use it to determine what interest rate to offer you. When it comes time to shop around for a loan, ask the lender what credit score is needed for a lower rate. If yours is close, you could try to improve it before you submit a formal loan application.

This snapshot of your financial situation will guide your next steps.

Step 2: Choose your consolidation strategy

The different approaches to debt consolidation each have pros and cons. 

• Personal loan: Personal loans are often for amounts between $5,000 and $50,000. This type of loan typically has a lower interest rate compared to credit cards. Most lenders charge a fee for making a personal loan. You may need a fair or better credit score to qualify. With a lower score, the personal loan you qualify for might not save you money over a credit card. Compared to credit cards, the minimum monthly payment might be higher because most personal loans are designed to be paid off within two to five years.

• Home equity loan or HELOC. If you own a home and sufficient equity, you could borrow against it to pay off your unsecured debts. Equity is your home’s value minus the amount you owe on your mortgage. A home equity loan or HELOC is a second mortgage. Typically, these loans have lower interest rates compared to credit cards or personal loans. Most lenders charge a fee for the loan. If you don’t repay this type of loan, you could lose your home.

• Balance transfer credit card: If your credit score is good enough to qualify for a credit card with an attractive balance transfer offer, you could transfer your higher interest credit card debts and temporarily save money on interest. There’s usually a fee for each balance transfer. Transferring balances could also result in a juggling act that leaves you in even more debt than you started with. 

When you research each option, compare terms and interest rates. Check with lenders who start by doing a soft pull on your credit (one that won’t hurt your score). 

Step 3: Create (or revamp) your budget

Not everyone gets into debt because of overspending, but if you did, it’s time to create a new budget that guides you to spend within your means.

Even if your debt was caused by factors outside your control, revamping your budget could help you work toward a bigger emergency fund so that you can more easily cover unexpected expenses in the future. 

• Analyze your spending habits. Take a look at where your money goes each month. The goal is to identify expenses you could reduce or eliminate so that you can put more toward debt, and later, toward savings.

• Track your income and expenses: Within two to three months of tracking, you’ll have a pretty good idea of how much money comes in and where it goes. Use a free budgeting app to make it easier.

• Choose a budgeting method. Envelope budgeting means you designate an amount of money for each category each month and stop spending when that money is gone. The 50-30-20 budget guides you to spend no more than 50% of your money on needs, 30% on wants, and 20% on debt, and later, savings. Some people cut back on wants when they want to pay off debts faster. Choose a budgeting style that you feel comfortable with.

Your budget is your opportunity to make intentional choices every day to reach your goals.

Step 4: Choose a lender 

When you apply, don’t be afraid to ask a lot of questions, and take your time before deciding. This is your financial future we're talking about.

• Compare interest rates: Even a small difference in the interest rate could save you—or cost you—a lot over the life of the loan.

• Look for fees: There is such a thing as a no-fee loan, but in those cases, the interest rate is higher. It’s a good idea to compare the APR, which includes the interest rate but could be a little higher because it also considers fees. 

• Consider whether the lender is a debt expert. Lenders have different personalities, just like people. Look for one who understands every facet of debt and the many ways to deal with it. You want a partner who can help you throughout your journey out of debt.

Step 5: Celebrate wins along the way

Debt consolidation won’t solve your debt problems overnight. Dealing with debt takes time, discipline, and a positive mindset. The right debt consolidation strategy could relieve the pressure on your budget, save you money in the long run, and simplify your financial life. 

• Track your progress. Keep track of your debt balance. Watch it go down.

• Review your budget regularly. A budget isn’t set-it-and-forget-it. You may need to adjust yours when occasional needs force you to cut back on regular spending. That’s normal and to be expected. Building the ability to handle ups and downs is a big part of improving your financial life. Life happens, but your goals can remain the same.

• Stay motivated: Visualize your debt-free future. Celebrate milestones. Congratulate yourself frequently.

• Get support: The debt journey might be easier with buddies. Chat with your family and friends about debt, and whether anyone you know wants to get rid of their own debt. You might be surprised at how many people feel the same way you do, or have already done what you want to do. You could also talk to a financial professional who’s trained to help people create and live by a budget. You don’t have to go it alone.

Debt consolidation is more than a financial strategy—it's a mindset shift. It's about taking charge of your finances, creating a plan, and sticking to it. There may be twists and turns along the path but with grit and planning, you can reach your financial destination.