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What is Debt Consolidation & How it Works

what is debt consolidation?

What is debt consolidation?

If you’re wondering “what is debt consolidation”, then keep reading. This article has all you need to know about how debt consolidation works and how it could help you.

Debt consolidation is paying off existing liabilities and consumer debts by refinancing them into a newly created loan or using the equity in an existing loan. Multiple debts are combined into a single, larger debt (usually a loan) with more favorable payoff terms—a lower interest rate, lower monthly payment, or both.

Debt consolidation can be used as a tool to address student loan debt, credit card debt, and other liabilities. Aside from simplifying a borrower’s repayment effort by eliminating multiple monthly payments in favor of one, effective debt consolidation can also improve credit ratings and/or create additional borrowing capacity. When consolidating your debts, it is crucial to shop for the most appropriate consolidation loan from the most flexible, accommodating lender.

Who is debt consolidation right for?

Like any financial maneuver, debt consolidation is a good decision for some borrowers and one with potential pitfalls for others. For instance, debt consolidation is a straightforward way for those who have sufficient income and are currently servicing their debts adequately to simplify their repayment plan (while also potentially lowering their interest repayment or shortening their repayment period, or both). For those who have lost their income or are in a state of delinquency, a consolidation loan may either be out of reach, or may be a more expensive option than their current repayment setup. However, it is always beneficial for you to reach out to your lender, especially a credit union if you are having trouble paying. Often they can work out a temporary repayment plan until you get back on your feet.

Types of Debt Consolidation

There are different types of debt consolidation options available to borrowers. Multiple debts can often be consolidated into a newly acquired loan or by using the available equity in collateral you currently own (such as a home, vehicle, or other valuable asset). Common debts that are consolidated are credit cards, personal loans, and student loans. Common consolidation loans are home equity lines of credit (HELOCs), auto equity loans, credit cards, and second mortgages.

By consolidating debts using the equity available within an asset you own, you can often significantly reduce your interest repayment obligation for an “unsecured” loan such as a credit card or personal loan. This may require you to provide your vehicle title or the deed to your home as collateral for the consolidation loan.

Credit Card Debt

Credit card debt is perhaps the most common type of loan to consolidate when trying to streamline repayment and lower interest liability. Most credit card issuers provide a streamlined way to consolidate balances from other credit card providers through a balance transfer, and will often incentivize new cardholders to migrate other balances to a new card. While these balance transfer promotions can be very enticing with introductory rates of 0% or a very low Annual Percentage Rate, you should always review the succeeding rate after the introductory term (often 6, 12, or 15 months) and the fee associated with the balance transfer (often 3-5% of the amount transferred). If your consolidated balances are not paid by the end of the introductory term, you may discover that you are paying more in interest long-term. Balance transfer fees also add to your principal amount, which creates additional debt to be repaid.

Bearing this in mind, credit card consolidations through a balance transfer can be a very effective way to avoid late fees and allow you to “catch up” to your interest accrual. It’s important to develop a plan to repay consolidated balances within the introductory term and you may significantly reduce your interest repayment.

Student Loans

Student loans are often created in intervals throughout the student-borrower’s scholastic career, and it’s not uncommon for a graduate to begin servicing 15-20 different Federal and private loans shortly after they finish school. Most Federal programs aggregate these loans to help streamline the repayment, but you may consider whether additional consolidation options are available and appropriate for your specific circumstance.

The Federal government provides its own consolidation options through the Federal Direct Loan Program, which may not significantly lower interest repayment but will simplify the number of loans a graduate is servicing as they begin their career. Bear in mind that private student loans do not qualify for Federal consolidation.

Most student lenders—whether Federal or private—provide a reasonably long repayment term for borrowers. When considering consolidation options, be sure to review changes to your repayment term and whether they may adversely impact your budget on a monthly basis.

Other High Interest Debt

Beyond credit cards and student loans, you may have additional liabilities such as “payday” or title loans, medical debt, or other unsecured loans (meaning loans not tied to collateral) that have a high effective interest rate. Refinancing these debts through consolidation is often a smart move because creditors understand it improves a debtor’s likelihood to repay their obligations. For that reason, and specifically if your consolidation involves securing your debts to an asset-based collateral, you can often significantly lower your interest rate.

Debt Consolidation Pros & Cons


  • You may reduce your effective Annual Percentage Rate, thus lowering your monthly payment
  • You may shorten your loan repayment term
  • You may both reduce your monthly payment AND shorten your loan repayment term
  • Streamline several small monthly payments into one larger, simple monthly payment
  • Use available equity (value) in an asset (such as a home or vehicle) to dramatically lower interest repayment
  • Avoid late fees
  • You may improve your credit score long-term


  • Longer repayment schedules may increase your overall interest repayment
  • Shorter repayment schedules may increase your monthly payment amount
  • You may lose special provisions related to Federal student loans, such as discounts or rebates
  • You may cause short-term damage your credit score by replacing multiple older credit histories with a single newer one
  • Your consolidation loan may require you to pay a “transfer fee” that is a percentage of the amounts being transferred, thus increasing your debt
  • If you choose to refinance your debts to an asset, you put that asset at risk of repossession if you default on your loan

Frequently Asked Questions (FAQ)

Will a debt consolidation loan affect my credit?

The short answer is Yes. The longer answer is that while your credit will almost certainly be impacted, the exact extent of the impact and whether it is positive or negative is entirely based on your unique circumstances.

Consolidating loans can help you to repay your debt more quickly and create additional utilization-to-capacity room, which increases your credit rating. However, replacing longer debt histories with a shorter one has an adverse impact on your score. Generally speaking, you may expect to see a short-term decline in your credit rating and a longer-term gain when you consolidate your debts.

What’s the difference between an unsecured loan and a secured loan?

An “unsecured” loan (often referred to as a personal loan or a signature loan) is a loan that does not require the borrower to present collateral in exchange for the loan proceeds. A credit card is the most common example of an unsecured loan. Since an unsecured loan has been made in the absence of collateral, its “collectability” in the event of a payment default is very low and is therefore typically a more expensive loan.

By contrast, a “secured” loan is made in exchange for the rights to an asset, such as a home, vehicle, or a similar valuable good that can be repossessed in the event of payment default. Since a secured loan has collateral (the afore-mentioned asset) that can be re-marketed to recover a creditor’s loss, it is considered a less risky loan and is therefore typically priced at a lower interest rate.

Apply for a Debt Consolidation Loan with HFS Federal Credit Union

If you’re overwhelmed by debt, or just looking for a way to reduce your interest or monthly payments, consider applying for a Personal Loan with HFS Federal Credit Union. Our experienced lending staff can help review your situation and find the best option for you. Contact our loan experts at (808) 930-1400 or apply online at

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