Debt Consolidation Loans
What is a debt consolidation loan?
A debt consolidation loan is a fixed-rate personal loan that helps borrowers to pay off or reduce their unsecured debts by managing multiple debts into one monthly payment. A smart debt consolidation strategy can lower your interest rates, make it easier to track and deal with monthly payments as well as pay out the debts quicker. Consolidating your debts can potentially improve your credit score.
On this page:
- How does a debt consolidation loan work?
- How to qualify for a debt consolidation loan?
- Debt consolidation loans and bad credit
- Can a debt consolidation loan hurt my credit score?
- Where to get a debt consolidation loan?
- What happens if you opt for a debt consolidation loan?
- Types of debt consolidation loans
- Debt consolidation with an installment loan
- Advantages of debt consolidation loans
- Disadvantages of debt consolidation loans
- Which debt consolidation loan company is the best?
- Debt consolidation vs. balance transfer card
- Debt consolidation loan alternatives
How does a debt consolidation loan work?
1. Decide which debts to pay off
Consolidate payday loans, credit cards, and other high interest rate loans in the first place. Calculate all interest rates and fees that you are paying now and check whether there are penalties for early repayment of any of your debts.2. Review your loan offers
Find a place where you want to apply for a debt consolidation loan, be it an online lender, a broker, or a credit union. Apply to see what offers you get based on your income, current debts, and credit score. If there is a loan offer that is more cost-effective than the current ones, consider accepting the offer.3. Start paying down your debt
Once you have determined your payment schedule with the lender, you should make sure that you do not miss any payments. This way you will pay down your debt much quicker and improve your credit score at the same time.
How to qualify for a debt consolidation loan?
In general, lenders require that the borrower:
- is at least 18 years old
- has a valid and verifiable bank account
- can provide a valid personal ID
- is a US resident and is not in bankruptcy
Debt consolidation loans and bad credit
As for credit score, the general rule of thumb is that better credit history gets you a better APR (Annual Percentage Rate) and terms, while some lenders may even refuse to provide a debt consolidation loan to people with very bad credit scores. In some cases, taking a personal unsecured loan to consolidate your debts, like credit card debts, can help you improve your overall bad or fair credit score.
If you still fail to land a good debt consolidation loan offer because of bad credit, it is worth looking into ways of improving your credit score, such as: checking your credit report for possible mistakes, improving your debt-to-income ratio, or adding a co-signer.
Can a debt consolidation loan hurt my credit score?
Applying for a debt consolidation loan may temporarily hurt your credit score if the lender will perform a hard credit check. Some lenders perform only a soft credit check which does not affect your credit score. However, in any scenario, if you make your monthly payments on time, this should make a great improvement of your credit score over time.
Where to get a debt consolidation loan?
Credit unions are not-for-profit financial organizations that may offer more flexible terms and lower rates than online lenders. Federal credit unions have a maximum APR limited at 18% which is much lower than online lenders can offer. Keep in mind that applying for a loan with a credit union involves a hard credit check which will appear on your credit report.
Online lenders have several advantages. First of all, you can easily apply for a loan online without the need to visit a physical location, which is much safer during a coronavirus pandemic. Secondly, online lenders have lower requirements, compared to banks and credit unions, which is good for borrowers with low credit scores. However, this also means a possibly higher APR.
Visiting a local bank is also a popular option for borrowers with credit scores above 600. Usually, banks have higher requirements but can also offer a loan on better terms with a lower APR than online lenders. However, most banks do not offer an option of getting a debt consolidation loan without visiting the office.
What happens if you opt for a debt consolidation loan?
If you take a debt consolidation loan, you are paying off all your loans by taking one big online loan. This way you are not dealing with multiple lenders or credit card debts. Instead, you are paying only one EMI to a single lender or a financial institution.
- Reduce the number of EMIs.
- Pay only one EMI
- Deal with only one lender
- Money against loans is debited only once a month and not multiple times
Types of debt consolidation loans
There are numerous types of debt consolidation loans to choose from. These vary from taking a new credit card to pay off outstanding on other credit cards to even taking a loan against the value of your house.
Balance transfer on credit cards
Some credit cards offer promotional events when the interest rate is 0% for a limited time. In such cases, it might be wise to use this option to consolidate debt.
Personal loan for debt consolidation
A personal loan is by far the most popular solution for those looking to consolidate all current loans & debts into one.
Home equity loan
If you are a homeowner then this option may be available, but keep in mind that failing to pay out such a loan may lead to serious problems.
Debt consolidation with an installment loan
Though there are different debt consolidation options available to people with fair or bad credit, some of these solutions come with interest rates higher than the rates of current loans that you have.
An installment loan may be a good solution for people who have credit scores below 600 and have extremely high interest unsecured loans, like payday loans. This option is also good for those who have no collateral to support the loan.
Find out more information on our installment loans page.
Advantages of debt consolidation loans
There are many advantages of opting for a single loan against multiple loans. It is very beneficial for those people who are burdened with paying EMIs multiple times in a month to different lenders.
Dealing with many payments can be incredibly stressful and may also be awfully expensive since the interest charged by different lenders varies.
Here's an overview of all the benefits you get with debt consolidation:
- Clear all credit card dues.
- Save on interest.
- Improve your credit score which will help in acquiring a new loan in the future if required.
- If repaid with discipline, it can make you debt-free sooner than you thought.
Disadvantages of debt consolidation loans
While the rate of interest and outgoing per month may reduce when you take a debt consolidation loan, remember the savings in your pocket may not be as attractive as you think. This is mainly because your prepayment timeline increases.
Similarly, by availing a big loan the total credit available also reduces. So when you go for a new loan your eligibility comes down. Also, note that many debt consolidation loans demand high monthly and additional processing fees.
- Overall outgoing may increase on account of the increased loan tenure.
- Credit eligibility reduces. This will be a huge disadvantage when you require a new loan.
- Improve your credit score which will help in acquiring a new loan in the future if required.
- Lenders charge a processing fee or additional charges.
Which debt consolidation loan company is the best?
The best debt consolidation loan company for you is one that can offer the lowest interest rate with terms that meet your needs. It takes some time and effort to find the best debt consolidation loan lender near you.
When evaluating debt consolidation loan companies, we suggest considering these features:
- Interest rates.
- Fees and penalties
- Loan terms
- Repayment options
- Customer reviews
Debt consolidation vs. balance transfer card
If you have a good credit score, then a balance transfer credit card is a good option to consolidate your debts. Such credit cards have an introductory 0% APR offered during a promotional period. A balance transfer credit card allows you to transfer your debts to the card and make 0% interest payments on the new credit card balance for up to 21 months.
By comparison, if you use a personal loan for debt consolidation over a balance transfer card, you'll get fixed monthly payments which makes paying out the loan easier, as well as the limits are typically higher, up to $50000 while balance transfer cards are usually capped at $15000.
Debt consolidation loan alternatives
If debt consolidation loans do not work for you, here are some alternatives worth considering.
Debt snowball method
The debt snowball method is a debt reduction strategy where you pay off the debt in order of smallest to largest, even if the largest ones have higher interest rates. When the first debt is paid in full, you roll the money you were paying on that debt into the next one to get momentum.
Consider a secured loan
Secured loans require some form of collateral, such as a vehicle, home, or another type of asset. The collateral usually must be worth enough to cover the loan amount in the event that you default. Because of collateral, typically it is easier to get approved for such loans and in some cases, you may even get a lower interest rate.
Look into a home equity loan
If you have equity in your home, you may be able to get a home equity loan or line of credit to pay off high-interest debt. Since you use your home as collateral, in most cases lenders will offer lower interest rates compared to unsecured loans. Keep in mind that if you fail to repay the loan, the lender might take your home.
Debt management plan
A debt management plan from a nonprofit credit counseling agency can help reduce your interest rate and pay off debt faster. With a plan like this, a credit counselor can help you formulate a repayment plan. Once you and your counselor agree on a plan, they will often try to negotiate with your creditors to see if they can get you a lower monthly payment and sometimes a lower interest rate.
In case you have tried all possible options with no success, speaking with a bankruptcy attorney might be your only way to get out of the debt trap and find relief. This is not an easy process, but the court might be able to prevent creditors from pursuing you.
Filing for bankruptcy will remain on your credit file for seven to 10 years and may affect your ability to obtain other loans in the future.