It is easy to feel overwhelmed and hopeless when you are drowning under a mountain of debt. It does not take long for small debts to spiral out of control and result in much larger sums owed. Soaring interest rates and late payments can all make the situation much worse. Fortunately, there are options available to consumers who want to get out of debt once and for all.
A debt consolidation loan is a popular option when you are looking to combine your existing debt obligations into one single manageable payment. Here is everything that you need to know about debt consolidation loans, the pros and cons of these types of financial arrangements, and alternatives to getting yourself out of debt and on the road to financial freedom:
What is a Debt Consolidation Loan?
A debt consolidation loan is any kind of loan that has the purpose of paying off current debts in one lump sum. This enables the borrower to deal with simply one monthly payment instead of several smaller debt payments. These loans can be a good deal if they offer lower interest rates and more favorable terms compared to the sum of your current debt payments. Not only will you be paying less money out each month, but you will also save money over the life of the loan because of the lower interest rates. This also simplifies your finances and makes it easier to visualize getting completely out of debt since you are only focusing on one payment.
A debt consolidation program generally rolls all of your existing monthly payments into one manageable debt payment. Debt consolidation loans are popular with consumers with varying levels of credit. Depending on your credit score, you will have different options to consider. For example, if you have a credit score or more than 700, you will be looking at a different set of options that somebody with a score of less than 600.
Types of Debt to Consolidate:
There are a variety of debts that are good candidates for consolidation. Nearly any type of unsecured debt is eligible to be rolled into this one monthly payment. Some of the most common types of debt that are consolidated include:
- Credit Cards – This is obviously the biggest problem for many consumers and the impetus of the decision to consolidate their debt so that the high interest rates of these cards are wiped out. When paying off credit card debt, it is important to carefully consider whether you want to close the account once it is paid in full. While you do not want to be tempted to spend your way back into debt again, it is always a good idea to leave your oldest credit card open. This will help to boost your credit score because a good part of this overall rating is based on the age of your oldest active account.
- Payday Loans – This circle of unrelenting debt is easy to get caught up in if you are not careful. Once you have consolidated this debt into one payment, it is important to not get trapped in the payday loan cycle again. Remember that many of these loan outlets are considered to be a predatory practice with little benefit to consumers.
- Bills in Collection – This type of debt can really hurt your credit, making it important that they are wiped out as soon as possible. While it will take a while for the credit ding to disappear from your report, rolling bills in collection into a debt consolidation loan is a good start in starting the process to erase it from your credit score.
- Student Loans – Although it is no surprise that some college graduates are left with mountains of student loan debt, using a debt consolidation loan is not always the best way to resolve this debt. Be sure to compare the interest rates of your student loan terms to the debt consolidation so that you know you are making a sound financial decision. Even if the student loan debt is eligible to be rolled into debt consolidation, you may be better off resolving this debt on its own because it is more forgiving and does not affect your credit score as negatively as other types of debt.
- Medical Bills – Like student loans, it is important to carefully examine the terms of your medical bills with the debt consolidation specifics. Many hospitals are willing to work with patients in paying off the medical bills at lower interest rates than any type of loan could deliver. In addition, creditors are generally more understanding about medical bill debt than other types of debt.
Pros of a Debt Consolidation Loan
- Lower Interest Rate – One of the primary reasons that people choose a debt consolidation loan is to lower the amount of money that they end up paying over the life of the loans or debt that they owe. A big selling point of a debt consolidation loan is that the interest rate is much lower than high-interest credit cards or other loans. This saves you money both in the short term and the long term.
- Only One Payment – It is much easier to manage your budget when you are only looking at one monthly debt payment each month. It is also more visible as this debt gets paid down. For example, you will get a bigger psychological boost to see this total go down $500 each month rather than seeing 10 smaller debts shrink by only $50 each month. Even though you are paying the same amount toward your overall debt, this mental boost encourages you to keep striving to become free of debt.
- Mitigate Damage to Credit Score – Staying ahead of your debt is an added bonus of a debt consolidation loan. With just one payment, you no longer have to worry about as many late or missed payments, reducing the chances that your credit score will take a hit. However, it is important to understand how closing accounts as you pay them may actually lower your credit score. More on that is discussed below in the credit section.
- Get Out of Debt Faster – If your credit score is less than desirable, a loan that is specifically designed to consolidate debt will help you to get out of debt as quickly as possible. A lower interest rate equates to lower monthly payments, allowing you to apply more to the principal each month. The sooner that you get out of debt, the faster that you will be able to put money toward things that really matter such as saving for your future, paying for your children's education, and family vacations.
Cons of a Debt Consolidation Loan
- Possibly Dig Yourself Deeper – One of the downsides of a debt consolidation loan is that it delivers the potential to dig yourself into a deeper financial hole. It can be tempting to suddenly have a zero balance on your credit card. If an inability to control spending is what you got into debt in the first place, it is likely that you may not be able to resist these impulses once again. It is not uncommon for that debt to grow back once it has been paid off. It is challenging to unlearn those bad financial habits. Instead, it may be more productive to establish good money habits rather than looking for the quick fix.
- Risk of Not Paying it Off – By taking on another loan, you run the risk of not being able to pay it off. This could ding your credit score even more than had you stuck with the existing debts. If you fail to make the payments on your loan on time, the creditors that you paid off with the consolidation may be able to bring those payments back.
- High Interest Rates – Compared to other types of loans, a debt consolidation plan may yield higher interest rates than if you looked elsewhere. For example, if you have solid credit, you may be able to take advantage of a credit card transfer program to pay the debt at much lower rates than your debt consolidation loan. As if with any big financial decision, it is important to look at the long term and short term implications before moving forward.
How does Debt Consolidation Affect Credit
It is nearly impossible to say for certain how a debt consolidation loan will affect your credit. There is a multitude of factors that go into an individual's credit rating. The one thing that is certain is that paying off debt will definitely improve your credit score. This is especially true if you are currently struggling to make the minimum payments on time. Once you only have one payment to worry about each month, it is less likely that you will be penalized with late fees and drops in your credit rating.
Conversely, a debt consolidation program can cause your credit to take a dive if you are not careful when closing accounts that have been paid off. Keeping your oldest account open with no balance will demonstrate responsibility with credit over time. This is a major factor in any credit report. If you do not trust yourself to not use your credit cards once they are paid off, you should close all but your oldest account and leave the card at home where you will not be tempted to use it on impulse purchases.
Types of Debt Relief Options
Credit Card Balance Transfer
This method of debt reduction involves transferring your credit card balances to a different card with a lower interest rate. This is only an option for those with good credit scores. The biggest advantage of this method is that you may be allowed to pay off the debt at absolutely no interest rate. The best credit card options often run balance transfer specials in which you pay 0% APR for up to 24 months. This gives you two years to pay off the debt at no additional cost to you. This is an easy thing that you can do with just a few clicks from your own computer.
The biggest disadvantage of this method is that there are usually fees associated with the transfer. In most cases, the fee is a percentage of the total amount transferred. It is important that you read all of the fine print before making the transfer. While this may be a good method if you know that you can pay off the entire balance before the special introductory rate expires, you may be left with bigger debt if you are unable to commit to this payoff. When the introductory rate expires, it is often replaced by a much higher rate than you were originally paying. If you decide to go this route, be sure to shop around and compare rates and terms so that you can find the best deal.
Home Equity Loan
This secured loan uses your home as collateral to take out money to pay off your debt. An advantage of this method is that you do not necessarily need good credit to qualify for the loan. However, it is extremely risky to put your house up as collateral. For most consumers, their home is their biggest asset. Putting it at risk just to pay off debt can land you in even more trouble.
Taking out a home equity loan may be a good solution if you have built up a lot of equity in your home. It is also not as frowned upon if your house is in an area with a healthy housing market. The last thing that you want is to not be able to pay off the home equity loan and the housing market to tank at the same time.
If you are planning to take out a home equity loan to pay off debts, it is vital that you have a solid financial plan in place. You also need to take care to pay attention to the possible closing costs so that you do not overextend your finances.
Another option is to take out a standard personal loan from a bank or other credit institution. If you can secure a lower interest rate on the loan than you are currently being held to with your credit card payments, this may be a viable option to help you to alleviate financial stress. A personal loan may also reduce the risk that you fall behind on your payments since you now only have to worry about one payment rather than a lot of smaller sums to be paid each month.
One of the drawbacks of a personal loan is that you likely need a solid credit score to qualify for favorable terms. You will also need a steady employment history. Before you sign on the dotted line, it is critical that you carefully examine the repayment terms. Even though you are now enjoying a lower monthly interest rate, the repayment terms may be longer, causing you to pay more interest over the life of the loan.
DIY Debt Snowball Method
If you do not want to take on an additional loan simply to pay down existing debts, you can try one of the most popular DIY methods by snowballing your payments until they are all paid off. Championed by financial guru Dave Ramsey, the debt snowball method is a proven debt reduction strategy in which consumers are instructed to pay off their bills in the order of smallest to largest sum owed, regardless of the interest rate.
When following this plan, you will make only the minimum payments on every debt except for the one with the smallest balance. With this debt, you will put as much money as possible toward paying it down. Once the debt is paid off, you move on to the next smallest amount owed, snowballing all of the money that you were paying on the last debt into paying off this current debt. You then repeat this method until all of the debt is gone.
One of the biggest advantages of the debt snowball method is that it is easy to understand and implement. The clear rules make it simple for consumers to follow. Another benefit is that you will be encouraged to keep the process moving forward once you pay off that first smallest debt. The mental boost provided by simply paying off one debt can encourage you to keep going. This method also helps you to see the fruits of your labor, encouraging you to develop these healthy financial habits as you strive to stay out of debt for good.
The biggest downside of this method is that you may end up paying more interest over the long run. Because you are focusing on the smallest debts as you move up the chain, you are not necessarily taking advantage of the lowest interest rates. Many people find that the psychological benefits provided by paying off debts quickly outweigh the money saved by paying those with the highest interest rates first.
DIY Debt Stacking Method
Similar to the debt snowballing method is the debt stacking method. Like the snowball method, this process encourages you to focus on paying down one debt at a time before moving on to the next. The difference between the two approaches is that the debt stacking method advises that you pay off the debts with the highest interest rates first and then move down to the lowest interest rates. While this may take a long time and the psychological benefit may not be as immediate, you will save money on interest by knocking out the highest rates first.
Debt Relief Programs
A debt relief program is often the last resort for people who are drowning in debt. A debt settlement company will negotiate all of your debts with the individual creditors for you. One of the central tenants of this plan is that you pay the settlement company to negotiate. Some debt relief programs will also make some of your debt payments for you, strategizing how to let some go into default so that the creditors are more likely to negotiate the balances down and save you money.
One of the biggest advantages of this type of debt reduction is that it is accessible to people with poor credit. Because your overall level of debt is reduced through the negotiation process, it is also one of the fastest ways to become free of debt. Some of these programs may also provide free credit counseling while going through the process. The goal of this counseling is to equip you with the knowledge that you need to make better financial decisions once you are finally out of debt so that you do not relapse.
Unlike many more strictly regulated enterprises, it is easier to get burned using a debt relief program. It is not uncommon for these types of companies to use predatory practices to lure in desperate consumers. For this reason, it is important to proceed with caution and go with the companies that have a proven reputation. You can guard yourself against a poor experience by refusing to pay the settlement fee prior to the debts being negotiated down.
One serious drawback to a debt relief program is that you may have to pay a tax penalty on the amount of debt that is reduced. This kind of program may also negatively affect your credit score both in the short term and in the long run. Although the debt consolidation company will be making all of your payments on your behalf, it is still your responsibility to ensure that those payments are made to your creditors on time. Your credit score will suffer if the debt repayment company fails to pay on time. If the program is not executed properly, it may result in legal ramifications that end up costing you more money out of pocket. The bottom line is that you need to proceed with caution.
Combination of Options
None of these options have to be all or nothing. It is possible to come up with your own personalized plan that relies on multiple debt relief options to pay off what you owe. For example, you can take out a home equity loan in a smaller amount to pay off your highest interest rate loans and then employ the debt snowball method to the more manageable amounts. Once those are paid off, you can turn your focus back to paying off the home equity loan. In the meantime, you have eliminated the debts that were costing you the most in interest each month.
You can also take it upon yourself to reach out to creditors to negotiate more favorable rates and terms. All of this combined with a stricter budget can help to guide you out of financial distress and put you back in control of your financial future.
At the end of the day, it is critical that you take into consideration all of the factors of your individual financial situation before making any big decision. Debt payoff is not a one-size-fits-all approach. Your total debt level, your current credit score and income, whether or not you own a home, and your projected financial growth over both the short term and the long term are all factors that need to be considered before deciding if a debt consolidation loan is the right fit for you. With the right planning, honest analyzation, and careful execution, you can choose a debt relief avenue that is the most favorable to your specific needs and preferences.
General Debt Consolidation Loan Questions
This section helps you understand the basics of debt consolidation loans.
What is a consolidation loan and how does it work?
A consolidation loan takes all your debt and puts it in one big loan with a lower interest rate. That means you pay less each month while paying down your debt faster.
What can I use a debt consolidation loan for?
You can use a debt consolidation loan to get rid of other debts you already have, like loans or credit card debt.
What type of loan can be used for debt consolidation?
There are lots of loans that can be used for debt consolidation. Personal loans, specific consolidation loans, home equity loans, and more.
How long does it take to get a consolidation loan?
Each company has its own application, decision, and disbursement process. You’ll have to find out more from the specific lender you’re considering.
Can you get a debt consolidation loan without collateral?
Yes, there are lots of companies that offer unsecured debt consolidation loans that you can get without collateral.
Can I consolidate my car loan and credit card?
It’s possible to consolidate more than one type of debt with a consolidation loan. You’ll need to talk to your lender to see about any restrictions.
How to consolidate payday loans and get out of debt?
The best way to consolidate payday loans is to get a consolidation loan. This will let you get out of debt by lowering your interest rate so you can pay your debt off faster.
Should I consolidate my credit cards with a loan?
That depends on your particular financial situation. Many people with credit card debt benefit from consolidation loans.
How do I know if my loans are consolidated?
You’ll know if your loans are consolidated because you’ll get a notice that they’ve been paid off and you’ll be billed for your new consolidation loan.
Can you pay off a debt consolidation loan early?
In most cases, yes. There aren’t very many consolidation loans that have an early repayment penalty.
How do I qualify for a debt consolidation loan?
Each lender has their own qualification process. You should find a lender you want to work with to plan how to qualify for the loan.
What are the drawbacks of a debt consolidation loan?
The biggest drawback to a debt consolidation loan is if you use it for credit cards and then spend on those credit cards again before the loan is paid off, as that increases your debt.
What is an advantage of getting a debt consolidation loan?
The advantages of getting a debt consolidation loan is that you pay lower interest and only have one bill to worry about.
Debt Consolidation Loans and Credit Scores
We’ll answer some of the most common questions about debt consolidation loans and credit scores in this section.
Does a debt consolidation loan affect getting a mortgage?
Not in most cases – the consolidation loan won’t make it more or less likely you get approved for a mortgage by itself. If you to lower your mortgage payments to decrease debt but don't have good credit then look at refinance mortgage bad credit options.
Can I get a consolidation loan with poor credit?
Yes, there are companies that specialize in consolidation loans for people with poor credit.
How to get a debt consolidation loan with bad credit?
The best way to get a debt consolidation loan with bad credit is to find a lender that specializes in working with bad credit loans.
How does a debt consolidation loan affect credit score?
A debt consolidation loan can have lots of different effects on your credit score depending on lots of factors. A certified financial specialist can help you understand the implications for your specific case.
Will a debt consolidation loan help my credit score?
It’s possible. If your consolidation loan lowers your credit utilization and you make on-time payments, then your credit score should go up. Use a monitoring service like Credit Sesame to keep an eye on your score.
Are FICO scores affected when shopping for a loan consolidation?
FICO scores aren’t affected by shopping for a debt consolidation loan any more than another financial product. Credit agencies group inquiries from lenders so you’ll only get one hard pull on your report.
Can I consolidate loans that are 12 years old?
Yes, there’s no limit on how recent a debt has to be for you to consolidate it.
Getting a Debt Consolidation Loan
This section answers popular questions people have about getting a debt consolidation loan.
How hard is it to get a consolidation loan?
It’s easier to get a consolidation loan than you might think. However, it depends on how much you need, why you need it, and your credit history.
Will I get approved for a debt consolidation loan?
It’s hard to say – you should try for consolidation loans that offer a prequalification or pre-approval process to be more confident about your chances.
How to get a debt consolidation loan with fair credit?
People with fair credit shouldn’t have too much trouble getting a consolidation loan – try debt consolidation lenders and 0% interest balance transfer credit cards.
Where can I get a loan to consolidate my debt?
There are lots of places to get a debt consolidation loan. Banks, online peer-to-peer lending networks, credit unions, and specialized lenders are all options.
Is it easy to get a debt consolidation loan?
It can be, it depends on your financial situation and the specifics of the loan you need.
Can I get a debt consolidation loan from my bank?
That depends on your bank – each bank has their own policies on debt consolidation loans.
Where is the best place to get a consolidation loan?
There’s no one best place to get a consolidation loan. You should shop around and look for lenders that specialize in your situation.
How to get an unsecured loan to consolidate debt?
The best way to get an unsecured loan to consolidate debt is to present a plan that shows why you’ll be able to pay back the loan.
Can I get a debt consolidation loan without a job?
It’s possible to get a debt consolidation loan without a job, but you’ll need to have some other form of income for the lender to trust you’ll be able to pay back the loan.
Can I get a debt consolidation loan with a cosigner?
Yes, adding a consigner can be a great way to get a debt consolidation loan when you’re having problems getting approved.
Specific Types of Debt Consolidation Loans
This section covers specific types of debt consolidation loans.
Is a personal loan a good way to consolidate debt?
It can be, so long as the interest rate on the loan is lower than the average interest rate of the debt you’re consolidating.
Can you consolidate debt into a new home loan?
That depends on a few factors, you’ll need to talk to your lender about restrictions on how you use your loan.
Can you use a home equity loan to consolidate debt?
Yes, you can use a home equity loan to consolidate debt. It’s a fairly common option for homeowners. Though if your score is low there may not be a guaranteed home equity loan for bad credit. Talk to multiple lenders to find out.
How to get a loan to consolidate credit card debt?
There are a few ways to get a loan to consolidate credit card debt. There are credit card debt consolidation lenders that specialize in this. You can also use a home equity loan or a balance transfer credit card.
Can I include my car loan in debt consolidation?
It’s possible. You’ll need to talk to your lender to see if there are any restrictions on how you use your loan.
Can an SBA loan be used to consolidate debt?
Yes, small businesses can use an SBA 7(a) loan to consolidate debt, up to $5 million.
Can I add my spouses loans to my direct consolidation?
It’s possible, but you’ll need to talk to your lender to see if there’s any restrictions on that.
Can I consolidate a business funded loan that is secured?
Maybe, but it will take some doing. You’ll need to talk to the parties that hold the current loan about your options.
Consolidation and Student Loans
We’ll talk about debt consolidation for student loans in this section.
Am I eligible for PSLF if I consolidate loans?
Possibly, it depends how you consolidate the loans and the specific public service forgiveness program you’re using.
Are consolidation loans with Great Lakes covered by bankruptcy?
No, student loans and student consolidation loans cannot be discharged in most bankruptcy proceedings.
Are education loans easier to get than debt consolidation loans?
It depends on several different factors. You should talk to a loan officer or certified financial planner about your particular situation.
Can I consolidate FAFSA loans and Sallie Mae loans?
It’s possible to consolidate these loans, but doing so might affect your eligibility for loan forgiveness programs.
Can I consolidate loans after being on income based repayment?
Yes, repayment systems don’t affect your ability to consolidate your loans.
Can loans that received special consolidation be directly consolidated again?
It’s unlikely that you can get direct consolidation twice after special consolidation, you should talk to your loan servicer about your options.
Can I consolidate my Sallie Mae loans with direct loans?
You can consolidate your Sallie Mae loans with direct loans, but you should be aware that doing so can affect your loan forgiveness and income-based repayment protections.
Can I apply for loan forgiveness if I consolidate?
You can always apply, however the consolidation process can affect your eligibility.
Can a different loan servicer offer different consolidation repayment plans?
Yes, different loan servicers are different companies, so they can do business in different ways from each other.
Can a Stafford loan be consolidated with direct loans?
It’s possible to consolidate Stafford loans with direct loans, but you should be aware of loan forgiveness issues that can result from this.
Other Debt Consolidation Loan Questions
This section has questions that don’t fit into our other categories. Check here if you can’t find your answer elsewhere.
Can you file bankruptcy on a debt consolidation loan?
Depending on the type of debt consolidation loan, yes. As long as it’s not a student loan, you should be able to get it covered in bankruptcy.
What is the interest rate on debt consolidation loans?
The interest rate on debt consolidation loans depends a lot on other factors, like how much debt you’re consolidating, how long the term of the loan is, and your credit history.
What is a good APR for debt consolidation loan?
A good APR for a debt consolidation loan is any APR that’s lower than the average interest rate you’re paying on the debt that you’re consolidating.
Can there be 2 names on a consolidation loan?
Yes, there can be more than one signee or guarantor on a consolidation loan.