What a consolidation loan changes, and what it does not
A debt consolidation loan borrows one sum, pays off several balances, and leaves you with a single instalment schedule. Three things change and one important thing does not.
The rate changes. This is the whole economic case. If a lender will price your combined balance below the balance-weighted average of what you pay now, every month accrues less interest.
The structure changes. Revolving debt has no end date and a payment that shrinks as the balance falls. An instalment loan has a fixed payment and a fixed maturity, so the debt has a definite end. For many borrowers this discipline is worth more than the rate.
The credit-file treatment changes. Moving card balances into an instalment loan removes them from revolving utilization, which is the second-heaviest input to a credit score. Paying $15,700 of card debt off with a loan can take utilization to near zero in one step — an effect the interest arithmetic does not capture at all. The credit utilisation calculator quantifies it.
What does not change is the amount you owe. Consolidation moves debt, it does not reduce it. The offer only makes you better off through the rate and the term, and it makes you worse off through the origination fee. That is the entire trade, and the arithmetic below is how you settle it.
The fee is the term people underweight. Personal loan origination fees are commonly a few percent of the loan and are usually deducted from the proceeds, which means you must borrow more than your debts to clear them and then pay interest on the fee for the whole term. Because it is a prepaid finance charge, it also drives a gap between the quoted rate and the disclosed APR under Regulation Z — see the loan APR calculator for how large that gap gets on a short loan.
Pricing both sides on the same basis
The current debts. Each balance, at its own rate and its own current payment, clears in
n = −ln(1 − i·B / M) / ln(1 + i)
and costs n·M − B in interest. Notice the condition hiding inside the logarithm: if i·B ≥ M the argument is zero or negative and there is no solution, because the payment never covers the interest. That is not a mathematical curiosity — it is the exact situation a minimum-payment schedule on a high-rate card produces, and the calculator reports it as a debt that never clears.
The consolidation loan. If the fee is financed, you must borrow L = ΣB / (1 − φ) to net your total balances after a fee of φ. Dividing rather than multiplying matters: a 5% fee on a $15,700 payoff requires borrowing $16,526, not $16,485. The payment is the usual M = L·r/(1 − (1+r)−N).
Comparing them. Put both on a cost-above-debt-retired basis. The current schedule costs Σ(nⱼMⱼ − Bⱼ). The consolidation costs M·N + cash fee − ΣB, which counts the financed fee automatically because it is inside M. Subtract, and you have the saving.
The break-even fee. Set the two costs equal and solve for φ. With a financed fee this gives
φ* = 1 − (ΣB × payment factor × N) / (current interest + ΣB)
where the payment factor is r/(1 − (1+r)−N) per dollar borrowed. That single number tells you how much fee the offer can bear before it stops being worth taking, and it is the cleanest way to compare two lenders whose rates and fees differ in opposite directions.
Worked example: $5,000 at 24%, consolidated at 12%
You owe $5,000 on a card at 24% APR and pay $200 a month. A lender offers 12% over 36 months with a 5% origination fee deducted from the proceeds.
- Current payoff period. The monthly rate is 24% ÷ 12 = 0.02. Then i·B/M = 0.02 × 5,000 ÷ 200 = 0.50, so n = −ln(0.50) ÷ ln(1.02) = 0.693147 ÷ 0.0198026 = 35.00 months.
- Current interest. 35.0027 × 200 − 5,000 = 7,000.54 − 5,000 = $2,000.54.
- Amount to borrow. With the fee financed, 5,000 ÷ (1 − 0.05) = $5,263.16.
- New payment. At 1% a month over 36 months the payment factor is 0.03321428 per dollar, so 5,263.16 × 0.03321428 = $174.81.
- Cost of the consolidation. 174.81 × 36 = $6,293.23, less the $5,000 of debt retired = $1,293.23.
- Net saving. 2,000.54 − 1,293.23 = $707.31, with the payment falling from $200 to $174.81.
- Break-even fee. 1 − (5,000 × 0.03321428 × 36) ÷ (2,000.54 + 5,000) = 1 − 5,978.57 ÷ 7,000.54 = 14.60%. The 5% quoted is comfortably inside it.
Two variations show where the case breaks. With no fee at all, the cost falls to 166.07 × 36 − 5,000 = $978.52 and the saving rises to $1,022.02 — so the 5% fee costs $314.71 of the benefit. And if the same 12% loan were written over 60 months instead of 36, the payment would drop to about $117 but you would pay interest for two extra years, which is where a longer term quietly consumes the rate advantage.
Reading the answer
Check the term first, not the rate. The most common way a consolidation offer disappoints is a term longer than the payoff period you were already on. If your debts would clear in 35 months at your current payments and the loan runs 60, you have bought a lower payment and sold two years of extra interest. The calculator warns when the new term exceeds your current payoff period; take that warning seriously.
Use the break-even fee to compare lenders. Two offers — 11% with a 6% fee against 13% with no fee — cannot be ranked by inspection. Run both and compare net savings, or compare each quoted fee against its own break-even. A quoted fee well below break-even leaves room; one close to it means the offer is marginal and a small change in your assumptions flips it.
Watch the payment direction. A lower payment is cash-flow relief, not a saving. If you can afford your current combined payment, the strongest move is to take the consolidation loan and keep paying the old amount, sending the difference as extra principal. That captures the rate advantage without lengthening the debt.
Be honest about the accounts you are clearing. The whole calculation assumes the card balances stay at zero. Consolidating and then rebuilding the balances leaves you with both the loan and the cards, which is materially worse than doing nothing. If you are not confident about this, the behavioural approach in the debt snowball calculator may serve you better than the arithmetic one.
Do not consolidate cheap debt. If one of your balances is already below the offered rate, moving it raises its rate. Run the calculator with only the expensive balances entered and compare against consolidating everything.
Months to clear a balance, by APR and payment size
| Payment as % of balance | 12% APR | 18% APR | 24% APR |
|---|---|---|---|
| 2% | 70 months | 93 months | never clears |
| 3% | 41 months | 47 months | 55 months |
| 4% | 29 months | 32 months | 35 months |
| 5% | 22 months | 24 months | 26 months |
The 'never clears' cell is exact rather than approximate: at 24% APR the monthly interest is 2% of the balance, so a payment of 2% covers the interest and nothing else. Any payment percentage at or below APR ÷ 12 leaves the debt permanent, which is the strongest single argument for consolidating a high-rate balance.
What this comparison does not include
- Prepayment penalties on the existing debts. Rare on cards, occasionally present on older personal loans. Check before assuming the payoff figure is the balance.
- Balance transfer alternatives. A 0% promotional transfer with a 3% to 5% transfer fee can beat a consolidation loan over a short horizon, but the rate reverts and the balance stays revolving.
- Secured consolidation. A home equity loan usually carries a much lower rate and converts unsecured debt into debt secured by your house. The arithmetic looks better; the downside risk is completely different.
- Credit-score effects. Moving revolving balances into an instalment loan usually helps utilization and adds a hard inquiry and a new account. The net is normally positive after a few months.
- Variable rates. This calculator assumes a fixed rate for the whole term. Price a variable offer at its lifetime cap.
- Taxes. Interest on consumer debt is generally not deductible, so all figures here are after-tax already. Home equity interest may be treated differently depending on how the proceeds are used.
- Debt settlement and management plans. These are different products with different consequences and are not modelled here.
The origination fee is a finance charge
Under Regulation Z, an origination fee deducted from the proceeds is a prepaid finance charge and must be reflected in the disclosed APR. That is why a loan quoted at 12.50% with a 4% fee will show an APR meaningfully above 12.50% on the disclosure. Compare offers on APR rather than on the quoted rate, and remember that the same dollar fee raises the APR far more on a short loan than a long one — because it has fewer payments to amortise over.
The alternatives, and when each one wins
Do nothing but pay more. The simplest option and often the best. No fee, no application, no new account. If you can raise the payment on your highest-rate balance, the debt avalanche calculator shows what ordering the payments by rate is worth — frequently more than a consolidation loan's rate advantage, because it costs nothing to start.
Balance transfer. A promotional 0% period with a transfer fee of a few percent beats almost any consolidation loan while the promotion lasts. It fails when the balance is too large to clear inside the promotional window, because the reverted rate is usually a standard card APR. Work out the payment needed to clear the balance in the promotional months and be honest about whether you will make it.
Home equity. Lower rate, longer term, and your house as collateral. The rate advantage is real and so is the risk transfer; treat it as a different decision rather than a better version of this one.
Retirement plan loans. Cheap and dangerous — separation from employment usually accelerates repayment, and the money is out of the market meanwhile.
Whichever route you take, understand what the current balances are costing while you decide. The credit card interest charge calculator prices a single cycle, the minimum payment calculator shows what happens on autopilot, and the payoff calculator converts any level payment into a date. And before applying, check what a lender will see: the debt-to-income ratio calculator covers the ratio that most often decides whether the offer arrives at all.