Managing debt can be overwhelming: Juggling multiple debts at different interest rates, with different payment due dates and multiple creditors can be a complicated and expensive task. One smart strategy can be consolidating multiple debts into a single loan. In fact, doing so can have a positive effect on the debtor’s credit score if the consolidation helps the borrower eliminate missed or late payments. The borrower’s credit score will further improve as the total amount of debt goes down.

A consolidation loan, like any loan, requires a loan application and not everyone will qualify. If unpaid debts have left you with bad credit, debt consolidation can be more difficult and expensive than for other borrowers. Here are steps that will enable you to consolidate debt anyway and improve your financial health.

Check Your Credit Score

Start by checking your credit. Knowing where your credit stands is a crucial first step because consolidation options depend on it.

Every consumer can get a free credit report once every twelve months from each of the three major credit reporting agencies (Equifax, Experian and TransUnion) by visiting the website.

Free credit scores are not included with free credit reports, but they are available from a variety of sources. Look on your credit card or loan statement, or sign up on websites that offer free credit scores. (See Top Places To Get A Free Credit Score Or Report.)

Understanding Debt Consolidation

  • Debt consolidation doesn’t get rid of debt. What it does is consolidate multiple accounts into one.
  • The total monthly payment amount might go down, but total amount of interest paid and the length of time to repay all of the debt will likely rise.
  • Once credit card accounts are paid off, think hard about whether to close them to avoid the temptation of running up new charges. Keeping paid-off accounts open after consolidation puts the borrower at risk of taking on even more debt.

Debt Settlement Is Different

An Internet search for “debt consolidation” yields many companies that advertise great success in what they call debt consolidation. Most actually offer debt negotiation and settlement services, not loans.

Settled debt (when a creditor agrees to accept less than the amount owed) is not the same as consolidated debt. Settled debt can be reported to the IRS, resulting in a tax liability on the amount forgiven.

Before you agree to anything, see A Guide To Debt Settlement and 7 Ways To Consolidate Debt to learn the range of strategies for making debt more manageable.

Research Your Options

A borrower can consolidate debt in a number of ways. Here are a few.

Bank loan. Bank loans tend to have more favorable terms (lower interest rates) than credit cards and some other consolidation options, but may not be available to borrowers with bad credit.

Credit card balance transfer. Credit card issuers famously push low and 0% balance transfer offers in an effort to acquire more of a borrower’s debt. For cardholders who qualify, the offers can be a great way to save money in the short term. This option requires being offered a credit line sufficient to cover the debt that the borrower wants to consolidate. Also, pay close attention to what the APR on your balance will be after the initial offer period has expired; with bad credit, the interest rates you are offered are likely to be high. (See The Pros And Cons Of Balance Transfers.)

Peer-to-peer lender. Lenders such as Prosper and Lending Club have higher loan approval rates than banks and are known to have lower minimum credit score requirements. Approval is, of course, case-by-case.

Home equity loan. A borrower who is also a homeowner with equity may be in a good position to leverage that equity into a debt consolidation loan. One advantage is that the new monthly payment obligation can be much lower than it was pre-consolidation. One disadvantage is that many home equity loans have repayment periods of 10, 15, 20 or 30 years and can drastically increase the amount of time it takes to repay the debts. And, of course, if you don't make the payments, you are risking your home. (For more, read Using Home Equity Loans For Debt Consolidation.)

Debt management plan. Borrowers who want to knock down their debt in three to five years and learn new financial management skills in the process are great candidates for a debt management plan (DMP). In a DMP, a credit counseling agency handles the consolidation and the borrower makes one monthly payment to the agency. The agency fields calls from collection agencies. It also negotiates reduced fees and interest rates. The terms are strict (credit accounts are closed). Also, the borrower may experience further credit score damage during the repayment period. (See What are some examples of a debt management plan (DMP)?)

Work Toward Qualification

A consumer starting out with bad credit has limited options. To increase available options, credit score improvement is imperative. Because the reasons for a poor score vary, figure out the reasons for your bad score and address them.

Your payment history and credit utilization ratio (the amount of debt you carry in relation to the amount of credit available to you) are the most influential factors in a credit score. Credit utilization is likely to be high for any consumer researching debt consolidation, so the consumer must focus sharply on making all payments on time and avoiding new debt.

Talk to a Credit Counselor

Debt consolidation is most effective when part of an overall financial education program that leaves the borrower better equipped to avoid debt in the future. The best thing a debtor can do is incorporate the consolidation plan into a new and better financial management strategy.

A credit counselor is an excellent resource. Free and low cost help is available in all 50 states.

Learn more about finding a credit counselor – and click here and here for consumer advice on from the U.S. government on avoiding scams.

The Bottom Line

Thorough understanding of the consolidation plan is critical. No matter what route you choose, read the fine print. Understand the interest rate, payment amount and repayment period on the consolidation loan, as well as any fees or penalties that could arise. Also understand how the consolidated and new debt will be reported to the credit bureaus. Beware of any company that promises to erase your debt or settle it for pennies on the dollar.

Remember that acquiring any additional debt negates the consolidation and payoff progress. Even if your new loan doesn’t require it, think about whether you should close your paid-off credit accounts after consolidating the balances. Your credit utilization ratio may go up (resulting in a dip in your credit score), but new debt could have even more devastating financial consequences.

Leave the accounts open only if you are confident in your ability to keep the balances at zero. Your unused credit and the age of your accounts will help your credit score.