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- Debt consolidation loans take multiple streams of debt and combine them into one loan with a fixed, monthly payment.
- Only consider a debt consolidation loan if you're offered a lower interest rate than your previous loans.
- Debt consolidation loans can help you stay on top of your debt payments only if you can feasibly make the monthly payments, both now and in the future.
A debt consolidation loan is a type of personal loan that allows you to roll multiple debts into one loan with one fixed monthly payment. Consolidation is a popular debt relief method that borrowers use to help make their debt more organized and less expensive over time.
Just like with other loans, each lender will offer different terms and conditions. However, finding the right consolidation loan may require a bit more heavy lifting when comparing lenders. To be worth it financially, the rate on your new loan must be lower than that on your existing debts.
A consolidation loan doesn’t make any progress toward paying down your debts, and you’ll be paying it off for years. The key to making the most of your consolidation loan is to know exactly how the process works and how lenders differ.
This can help you stay organized and save money, especially if you have an overwhelming amount pile of high-interest debt, such as credit card debt.
What is a debt consolidation loan?
Debt consolidation loans are personal loans that consolidate multiple loans into one fixed monthly payment. Debt consolidation loans generally have terms between one and 10 years, and many will let you consolidate up to $50,000.
Debt consolidation only makes sense if the interest rate of your new loan is lower than the interest rates of the debts you’re consolidating. To optimize your total savings, focus on consolidating the debts with the highest interest rates first and keep your loan term as short as possible.
If your monthly payments are a bit too high for your budget, you may be able to extend the loan term. However, this may be more affordable in the moment, but you’ll end up paying more in interest in the long run.
What is the difference between debt consolidation and a personal loan?
A debt consolidation loan is a type of personal loan. Some lenders offer loans specifically for consolidation, but they’re generally the same product. Both are fixed rate installment loans that can be used to consolidate a wide range of debts.
However, a personal loan does differ in that you can use the loan for a variety of reasons. Unless the lender has specific restrictions, you can use a personal loan to fund nearly every legal expense — including debt consolidation.
On the other hand, consolidation loans can only be used to combine two or more debts. The lender will typically prohibit using the funds for any other use.
How does a debt consolidation loan work?
Most debt consolidation loans are fixed-rate, which means the interest rate never changes and you make the same payment every month. So if you have three credit cards with different interest rates and minimum payments, you could use a debt consolidation loan to pay off those cards — leaving you with just one monthly payment to manage instead of three.
- Card 1 has a balance of $5,000 with an APR of 20 percent.
- Card 2 has a balance of $2,000 with an APR of 25 percent.
- Card 3 has a balance of $1,000 with an APR of 16 percent.
What to look for in a debt consolidation loan
If you’ve ever shopped around for a loan before, chances are you know what to look for. However, because consolidation loans involve multiple debt streams, that monthly payment can add up fast.
When trying to find the best option for your situation, compare at least a few lenders and pay close attention to the features. The loan details are on the lender’s website or within its terms and conditions page.
The details to keep an eye out for include — but aren’t limited to — the loan type, the term and whether it’s secured or unsecured.
The most common loan types include personal loans, 0 percent balance transfer credit cards, 401(k) loans and home equity loans. Some require collateral, like home equity loans and secured personal loans, while others don’t, so it’s worth understanding how each debt product works as it could impact other areas of your finances.
Be mindful of the long-term impact of your loan. For example, most 0 percent APR credit cards come with high rates after the introductory period ends. To avoid getting hit with sky-high interest charges, make sure you can pay down the balance within the interest-free time frame.
Longer loan terms could mean your monthly payments are more affordable, but it means that you’ll pay more in interest over the life of the loan. Evaluate your budget and don’t stretch your finances too thin, but you may find that a shorter repayment term is ideal. Despite the monthly payments being higher, you’ll pay far less in interest and will be debt free much sooner.
Secured debt is easier to qualify for and typically comes with lower rates, but this is only because the balance is backed by collateral. This means that the lender will require you to put up an asset to get approved. Depending on the loan requirements, this can be anything from a security deposit to a vehicle or even your home.
If you fail to make the payments or default on the loan, the lender can seize your collateral to make up for the delinquent payments. Unsecured loans are less risky for the borrower as they don’t require collateral, but they are generally more difficult to get approved for.
How to tell if a debt consolidation loan is right for you
A debt consolidation loan is worth considering if:
- You qualify for a lower interest rate. If you have good or excellent credit and plan to consolidate credit card debt, you’ll likely get a lower interest rate on a debt consolidation loan than you currently have on all your credit cards.
- You want a predictable monthly payment. The interest rate is fixed on most debt consolidation loans, which means you’ll get a predictable monthly payment that you can work into your budget. But a debt consolidation loan only makes sense if you can afford this amount.
- You’d prefer to pay a single creditor each month. Instead of scrambling to pay several creditors by the payment due dates, you’ll only pay one creditor each month and can avoid late payment fees and adverse credit reporting.
However, there are instances where it could be more sensible to explore other options. If your credit score is on the lower end, it’s highly unlikely that you’ll qualify for a debt consolidation loan with a lower interest rate than you currently have.
It’s best to avoid taking out a debt consolidation loan if money’s tight or you tend to overspend, making it challenging to afford the monthly loan payments or risk racking up even more debt. In this case, you’re better off reaching out to lenders and creditors to negotiate a payment arrangement that works for your finances.
The bottom line
If you can qualify for a low interest rate, a debt consolidation loan can streamline the repayment process and save you money in interest at the same time.
Before you commit to consolidating, explore your loan options and details, specifically the rates and fees of each. If you qualify for a lower rate and the monthly payments fit comfortably within your budget and you can manage the loan, then a debt consolidation loan may be the best relief method for your finances.