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When your personal finances teeter on the brink, your first instinct might be to do something drastic. Freeze your credit cards in a block of ice. Vow to never eat out again. Forgo your Netflix subscription.
These tactics may help, but financial experts say paying off debt requires a more comprehensive plan. One common strategy is debt consolidation, which involves rolling multiple debts into a single loan or credit card at a lower interest rate.
“Consolidating debt into one spot can be empowering and helpful from a psychological standpoint because it feels manageable,” says Mathew Isaac, associate professor of marketing at Seattle University’s Albers School of Business and Economics.
But debt consolidation is not a solution for everyone.
Consolidation works best for high-interest-rate debts such as credit cards. Households that carried credit card debt had balances averaging $6,849, costing an average of $1,162 in annual interest, according to a 2019 study by NerdWallet.
People whose income and expenses won’t allow them to resolve debt problems through consolidation or credit counseling should consider bankruptcy, says John Rao, an attorney at the National Consumer Law Center.
Consolidating your debt is only the start of a long process. Here are four keys to making it work.
Make a realistic budget
“In order for consolidation to work well, there has to be a clear plan of attack,” Isaac says.
A basic budget allocates money for debt payments, an emergency fund and contributions to retirement savings, but that isn’t enough when consolidating, says Lara Lamb, a certified financial planner at California firm Abacus Wealth Partners.
Successful budgeters avoid adding debt by accounting for infrequent expenses, such as car registration fees, as well as times of the year when expenses run high, like the holidays, Lamb says.
They also leave room for fun.
“People will go on a spending ‘diet’ and then feel like they’ve restrained themselves for so long that they go out and splurge,” Lamb says. “A realistic budget gives you enough to spend on things you value and you love.”
Quit using your cards
A cardinal rule of consolidation is not using your credit cards as you pay off debt.
People cut up their cards, lock them away or freeze them in ice, methods that seem extreme but experts say can be effective. Such tactics are known as “commitment devices” and help people achieve long-term goals, says Rebecca Rouse, director of the Financial Inclusion Program at Innovations for Poverty Action, a nonprofit that has conducted research on debt repayment.
To stay committed, write down why you want to be debt-free and how often you will make payments, and set periodic reminders to check your progress, Rouse says.
Locking away cards doesn’t mean closing accounts, which could hurt your credit. The one exception to the no-use rule is a nominal charge on your card every few months — paid on time and in full — to keep the account active and your credit intact, says Shawn Tydlaska, a certified financial planner at California firm Ballast Point Financial Planning.
Compare consolidation products
Balance transfer cards let you shift over debts from other cards and charge no interest for a limited time — the best ones offer from 15 to 21 months — after which a double-digit interest rate kicks in. Most cards charge balance transfer fees and require good credit scores and high incomes to qualify.
To improve your chances of getting one, add up all potential sources of income — including money in your savings account and 401(k) — and list that total on your application, not just your salary, Tydlaska says.
Debt consolidation loans typically come with lower interest rates than credit cards, and you can borrow more money. Rates depend on your credit profile and how much debt you have. A lender that sends money straight to your creditors can remove the temptation to spend that cash instead of using it to pay off debt. Only a handful of lenders — including Wells Fargo, Discover and FreedomPlus — offer this option.
» MORE: Debt consolidation calculator
Enlist support for your goal
Debt may feel like a shameful topic, but peer support is a powerful motivator and can hold people accountable, say Isaac and Rouse.
Debt support groups, online forums or a close family member can keep you on track to reach your goal. Even online lenders — such as Payoff and Prosper — offer tailored recommendations or apps to motivate borrowers.