10 Common Debt Consolidation Mistakes to Avoid

1. Not Working on Your Credit First

Your credit has a big impact on the interest rates lenders charge you, so taking steps to improve your credit before you apply can mean saving hundreds of dollars over the life of your loan. Here are some boxes to tick before you shop for debt consolidation loans.

Check Your Credit

Know where your credit stands before you decide to apply for a loan. You can check your credit report for free through Experian for a glimpse of what lenders see when they review your application. You'll see your payment history, balances, mix of accounts and inquiries on your report.

When you check your credit, be sure to look for any inaccuracies. You have the right to dispute information on your report that you don't recognize or believe is potentially fraudulent.

Lower Your Credit Utilization Ratio

Credit utilization is how much of your revolving credit (such as credit cards) you're using compared to your total available credit limits. If you're using more than 30% of your available credit on your credit cards, try to pay down your balances before you apply. If you can get your balances below 10% utilization, even better.

Learn more: Ways to Keep Your Credit Utilization Low

Build Your Credit History

Experian Boost^®ø®ø can help you raise your credit score instantly for free. You'll receive credit for the bills you already pay, such as streaming, utilities and rent.

Consider Waiting a Few Months

Building up your history by making on-time payments for a few more months can lead to gradual increases in your credit score. If you think you can wait to pursue debt consolidation, doing so could help you get better terms.

Learn more: Tips to Improve Your Credit

2. Not Considering All Your Options

A debt consolidation loan is just one strategy for paying off debt. Before you decide to proceed with consolidation, consider these other options.

DIY Payoff Plan

Use the debt snowball strategy or the debt avalanche strategy to decide which debts to prioritize paying off first. This can help you stay motivated and save money in interest.

Credit Counseling

If you're struggling with managing debt, budgeting, saving and other finance moves, working with a nonprofit credit counselor can help you chart a course forward.

Balance Transfer

If you have good credit, a balance transfer card can be a great tool for saving money on interest and paying off your debt. Balance transfer cards charge fees for transfers, however, and you may not get a credit limit high enough to cover all your debt.

3. Going Deeper Into Debt

A debt consolidation loan can help you wrangle your debts into just one loan, which is a relief from the immediate burden of many balances and payments due. But this sense of relief can also make your situation worse if seeing your credit card balances reduced to zero encourages you to spend more.

Ultimately, you want to be confident that you can avoid running up new balances before you decide to consolidate. Otherwise, you might end up finding yourself in more debt.

4. Taking on a Higher Interest Rate

Folding your debts into a debt consolidation loan won't save you money if the new loan charges more in interest. For a consolidation loan to be in your financial favor, its rate should be less than the average interest rate on the card balances you want to consolidate. To truly get a sense of what you're paying, you'll want to take the weighted average of your debts.

Weighted Average Interest Example

Say you have a credit card balance of $5,000 with an annual percentage rate (APR) of 20% and a loan balance of $10,000 with an APR of 11%. To find the weighted average, you'll need to multiply each balance by its interest rate and then divide by the total dollar value of all your debts. In this example, that looks like this:

1. Determine your APR charges: Multiply your APR by the total balances (0.20 x $5,000 and 0.11 x $10,000). Your totals are $1,000 and $1,100.
2. Add your APR charges: $1,000 + $1,100 = $2,100
3. Add your total balances: $5,000 + $10,000 = $15,000
4. Divide your APR charges by your total balances: $2,100 / $15,000 = 0.14

Expressing 0.14 as a percentage, you get a weighted interest rate average of 14%. You should look for a debt consolidation loan with a rate lower than that to save money.

5. Taking the Longest Term Available

While opting for the longest repayment term available can lower your monthly payments, you'll also pay more in interest over the life of the loan. That makes your debt more expensive. Aim for a shorter term length if possible.

Tip: The overall amount you'll pay on your consolidation matters, but so does the affordability of your payments. Make sure you're considering how much you can realistically afford as a minimum payment each month to avoid overextending your budget.

6. Not Checking for Fees

There are two fees to watch out for when you apply for a debt consolidation loan: origination fees and prepayment penalties.

An origination fee is an upfront charge lenders assess for simply processing your loan. If possible, avoid origination fees by shopping around for a loan that doesn't charge them.

You should also look for a loan without prepayment penalties. It's ideal to pay off an interest-bearing debt as quickly as possible, so look for loans that don't penalize you for paying early.

Learn more: Personal Loan Fees to Watch Out For

7. Missing a Payment

As with any type of debt, missing a payment by 30 days or more comes with serious consequences. Paying late not only has a serious negative impact on your credit score, but it also can trigger lender fees.

Tip: Set up autopay for at least the minimum due to avoid this mistake. Not only will you never forget to pay on time, but your lender might even offer a slight discount in interest for simply opting for automatic payments. Just be sure you always have enough money in your bank account to cover payment.

8. Only Paying the Minimum

While paying just the minimum will keep your credit intact, it's also the most expensive way to manage your debt repayment. You're far better off paying more than the minimum if you can. Just make sure to factor in any prepayment penalties your lender charges.

To find extra funds to direct toward paying off your debt sooner, consider:

• Taking on a side hustle to funnel cash toward repayment
• Directing any windfalls, such as your tax refund, to paying off the debt
• Trying a no-spend challenge or other savings challenges to put extra money toward the debt

Tip: If your lender allows it, you can also schedule automatic payments every two weeks, rather than once a month. Try to make these payments a little larger than just enough to cover the payment due.

9. Mistaking Settlement for Consolidation

You might come across debt settlement companies that claim you can turn your multiple high payments into just one payment, made directly to the company, and reduce the amount you owe your lenders. While that may sound tempting, you're better off avoiding settlement.

When you work with a debt settlement company, they typically encourage you to cease all payments to your lenders. This results in missed payments and delinquencies on your credit report, which does lasting damage. If you do settle for less than the total amount you owe, that will also be noted on your credit report and could be a red flag to future lenders.

In addition, debt settlers can't guarantee that they'll be able to negotiate all your debts down, which means there's no promise of success. Don't mistake these sometimes sketchy programs for consolidation.

Learn more: Debt Consolidation vs. Debt Settlement: Which Is Better?

10. Not Getting to the Source of Your Debt

What a debt consolidation loan is: a tool for lowering your monthly payments and paying less in interest. What it isn't: a magic eraser. Make sure you're getting to the root of how you ended up in debt. If overspending led you into a debt spiral, institute a new plan for living within your means, sticking with a budget and building financial stability to ensure you're on a positive path going forward.

The Bottom Line

When a debt consolidation loan is the right choice, your best bet is to shop around for the most beneficial rates and terms before you apply. An efficient way is to view debt consolidation loans matched to your credit profile. Compare loans tailored to your goals, paying attention to how the different rates and terms change what you'll pay over time.