personal loan for debt consolidation

The Definitive Guide on Personal Loans for Debt Consolidation

If you’re up to your eyeballs in debt, getting a personal loan for debt consolidation may seem like the perfect solution. You’ll get the benefit of paying one creditor each month instead of several. Plus, you’ll probably save on interest, and eliminate your balances more quickly.

With credit card debt at $16,048 for the average indebted household, there’s plenty of reasons for credit card users with revolving credit balances to consider a personal loan for debt consolidation.

Debt consolidation is the most popular purpose for personal loans. It can help you save money over the long term if the interest rate and fees on the new loan are lower. It can also offer a single structured installment loan payment that pays down the principle over a specific term, leaving you with one bill instead of many.

What is debt consolidation?

A debt consolidation loan is a loan you use to combine two or more debts into a single payment. The goal is usually to either lower monthly payments, reduce the overall cost, or simplify your budget. Instead of making many payments to different creditors, a debt consolidation allows you to make one loan payment.

Using a personal loan for debt consolidation allows you to pay off balances on high-interest credit cards. Instead, of variable rates and a revolving line of credit,, you’ll pay a fixed, monthly amount to the lender for a specific amount of time, usually two to five years.

The interest rate on the debt consolidation loan depends on your credit score.

How to choose a personal loan for debt consolidation

If you’re up to your eyeballs in debt, a personal loan may seem like the perfect way to find relief. You’ll get the benefit of paying one creditor each month instead of several. Plus, you’ll probably save on interest, and eliminate your balances more quickly.

However, since there are so many personal loans for debt consolidation out there, how do you know which options are worth considering?

1. Check the qualification criteria

Not all lenders are made equal. In other words, some will have more stringent qualification criteria than others. So, when conducting your initial search, you’ll want to be mindful of the following:

  • Minimum credit score: if the lender doesn’t post this information, call to inquire. Having a lower score doesn’t mean you won’t qualify, but it helps to know where you stand before applying.
  • Work history: It’s common for those who’ve recently entered the workforce to seek out more affordable financing for their credit card debt. However, some lenders require you to have been employed for a minimum number of years.

2. Compare interest rates

As with most debt products, the lowest interest rates go to the customers with the best credit scores. Having blemished credit doesn’t mean you won’t get approved, but the loan will be more costly. In some instances, high interest rates will negate the the benefits of debt consolidation.

The following scenarios illustrate why it doesn’t always pay to consolidate your debt using a personal loan:

3. Remember the fees

Some lenders cater to consumers with less-than-perfect credit. What seems like a good way to get out of debt could be another debt product riddled with fees. You should be mindful of origination fees before applying for a personal loan to consolidate your debt.

If you’re saving a minuscule amount just to make the payments easier, the costs of originating a new loan won’t make much financial sense. Also, inquire about prepayment penalties, because they could cost you a fortune if you plan to pay off the loan early.

4. Choose a repayment period

If you’re looking to consolidate installment loans, pay close attention to the proposed repayment period. An extended loan term may lowers your monthly payments but it also means you’ll pay more in interest over time. And, if the rate on the personal loan is similar to what you were already paying, you could end up paying more.

How to choose the right debt consolidation lender?

When looking for a debt consolidation loan, shop for a lender that has low fees, a low interest rate and flexible terms.

Also look at how much its late fees are and if it allows you to change the payment amount if you’re run into financial difficulties.

Ask if you can get a lower interest rate by getting a co-signer for the personal loan.

Credit counseling agencies vs. debt consolidation

Some companies that claim to offer debt consolidation products are really credit counseling agencies. Instead of paying off your debt and collecting the proceeds from you through a new loan, they pay your creditors on a monthly basis in exchange for a fee. Some also negotiate with creditors to secure a lower monthly rate or settlement. This may not be a bad idea if you don’t qualify for a debt consolidation loan and you need help to set up a budget and negotiate with lenders.

Where to Find a Personal Loan for Debt Consolidation

Are you ready to start searching for debt consolidation loans? To help you find the most competitive rates, use SuperMoney’s personal loans review and comparison tool. This tool allows you to view a variety of lenders along with their qualification criteria, APR ranges, and amounts. You can also see reviews from existing customers. It can be accessed free of charge and it only takes a few minutes of your time.

Most lenders also offer a pre-screening tool to help you determine if their loan products are a good fit. So, consider using this tool to help you narrow down your final options. There is no impact to your credit since it only performs a soft pull on your credit.

Finally, run the numbers to confirm you can afford the new monthly payment before signing on the dotted line.

Difference between debt consolidation and debt settlement

If you’re considering getting a debt consolidation loan, don’t confuse it with a debt settlement.

Some companies advertise that they can help consumers consolidate credit card debt through debt settlement. A debt settlement company will contact your creditors on your behalf to negotiate lower payments to settle the debt.

One of the disadvantages of debt settlement is it will hurt your credit score. For it to work, you must stop paying creditors instead pay into a separate account used to negotiate a settlement. 

If you stop paying creditors, they will probably report you to the credit bureaus, which will damage your credit. It could also eventually lead to debt collectors contacting you for payment. 

Debt consolidation is different. It doesn’t settle your debt for a lesser amount but provides a personal loan so that you can get a lower interest rate, lower monthly payments, or both.

When is the right time to merge debt?

By simplifying your debts to different creditors into one payment, you may find a personal loan for debt consolidation that has a lower interest rate than what you’re currently paying.

Consolidating debt can also help improve your credit score. By paying off high-balance credit cards, you can lower the credit utilization ratio on the cards.  

Using 35% or less of your credit limit is generally considered okay. Using a higher percentage can mean you’re maxing out your credit cards, which may hurt your credit score. The amount owed on accounts determines 30% of a FICO score, one of the major credit score companies.

If you have multiple credit cards with a high utilization ratio in each, you may not be able to get a personal loan to consolidate your debt because you likely won’t be approved for enough credit to consolidate.

Advantages and disadvantages of personal loans

Before getting a debt consolidation loan, here are some things to consider:

Interest rate

Check the interest rates on the loans you’re consolidating to make sure the new rate is lower.

Teaser rates

A debt consolidation loan may have a low interest because it’s a “teaser rate” that only lasts for six months or so. Find out how much it can increase.

Fees

Lenders may hide extra costs in debt consolidation loans. Ask the lender what the total cost is and how it is calculated. Origination fees can cost as much as 8% of the loan amount.

Check the savings are worth the effort

Calculate your current debt payments and include the fees and interest you pay now. Compare them to the monthly payment for the debt consolidation loan.

WEIGH THE PROS AND CONS

Compare the pros and cons to make a better decision.

Pros
  • Lower interest rates
  • Set monthly payments that make budgeting easier
  • Lower monthly payments
  • You can be debt-free faster
Cons
  • Can lose special protections (federal student loans)
  • It doesn’t always fix the problem
  • You could pay more in interest

Personal loans can simplify your financial life with one payment. By checking these factors, you can determine if a debt consolidation loan is worthwhile.

Should You Get a Personal Loan for Debt Consolidation?

If you compare the pros and cons of getting a new credit card to pay off existing credit cards, you may find a personal loan is a better option for debt consolidation.

When should you consider a debt consolidation loan?

A personal loan used to consolidate debt is a smart move if:

  • You are struggling to make the minimum payments on your credit cards
  • Creditors would not agree to lower your current interest rates
  • You have too many bills to handle each month

Before you choose a personal loan, though, there are some things to consider. Can adjustments to your budget help you pay down your credit card balances? If so, you may not need to take out a loan.

Balance transfer credit cards

Another option for multiple credit card debts is to transfer the balances to one credit card account. It sounds counter-intuitive, but it can work.

A 0% or low-interest balance transfer is often offered if you apply for a new credit card. One of your current credit card issuers may allow debt from other credit cards to be consolidated on its card at no interest within a promotional period of up to a year.

The disadvantage of the transfer is if you don’t pay the balance off before the teaser rate expires. That can take a lot of discipline. If you don’t think you can do that, then a personal loan may be a better idea.

Many low credit card transfer offers have a “balance transfer fee” this is usually a certain percentage of the amount transferred, the CFPB warns.

Also, if you use the same credit card to buy things after using the balance transfer offer, you’ll be charged extra interest on those purchases. You may want to use a different card for other purchases.

Other options

There are other ways to merge debt. Here are some options:

Debt repayment plan

Call your creditors to see if they’ll allow you to set a payment schedule that works within your budget. A small payment each month is better than nothing to creditors. Be sure you can afford the payment and don’t miss a payment, which can cause the debt collector or creditor to abandon the agreement.

Settle for less than you owe

This differs from what debt settlement companies offer you. You can try to settle for less than you owe with a debt collector. Be aware that one collector may accept a partial payment as a settlement and then sell the balance to another collector.

Home equity loan

This is risky because if you default on this loan, you could lose your house in foreclosure. A home equity loan will likely have a low interest rate, though the loan will decrease the net worth of your home until the loan is repaid.

The right strategy for debt consolidation

Your best strategy for using a debt consolidation loan is to pay it back as quickly as possible. If the fees and interest rate make the total monthly payment less than what you’re paying on multiple credit cards and other unpaid accounts, then a debt consolidation loan can be a good option.

But it only works well if you use it to pay off your debt faster. If you don’t, you could be extending your debt and end up paying more over time.

Also, remember what got you into this mess in the first place. If you don’t deal with the credit problems that led to your debt, then combining them into one loan won’t fix anything.

To compare personal loans that can be used to consolidate debt, check out the personal loan reviews at SuperMoney.

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