How do you qualify for a debt consolidation loan?

If you’re struggling with debt, a debt consolidation loan can help you get a handle on your overwhelming balances. It lets you roll multiple high-interest debts into a new loan product, preferably with a lower interest rate than you’re currently paying.

Depending on the loan terms, you can save on interest and pay off your balances sooner. But before applying, it’s best to learn what you’ll need to qualify for this type of loan, as well as consider the benefits and drawbacks they offer.

How to qualify for debt consolidation

When you’re ready to apply for a debt consolidation loan, here’s how to move forward.

1. Check credit score

You’ll typically need a credit score of at least 700 to qualify for a debt consolidation loan with a competitive interest rate. Although a lower credit score doesn’t automatically equal a loan denial, the borrowing costs will likely be higher. If that’s the case, it may not be worth it to take out a debt consolidation loan, as you won’t be able to save money on interest.

There are a few ways you can check your credit score. Some lenders, like SoFi, allow you to view your score for free if you have an account with the company. You can also request a free annual copy from all three credit bureaus by visiting AnnualCreditReport.com. Although these copies won’t have your actual score, they will give you an idea of where you stand with creditors and whether you need to improve your credit before moving forward.

2. List out debts and payments

Create a list of all the debt accounts you plan to consolidate. Include the amount you owe, the interest rate and the minimum monthly payment. Then, add all of them to know how big of a loan you’ll need to consolidate the balances.

After that, add up all of your minimum payment amounts to see how big a monthly payment on a debt consolidation loan you can afford. Once you have that down, use a loan calculator to see the terms and interest rates you’ll need to secure for the loan to serve its intended purpose.

3. Compare lenders

Banks, credit unions and online lenders offer debt consolidation loans. Research several options to find the lender that’s most ideal for you. When comparing lenders, consider the annual percentage rates (APRs), fees and any other perks they offer borrowers. Also, look at customer reviews to determine if they’re reputable.

If the lenders offer online prequalification tools, consider using them to gauge your approval odds. You can also view potential loan offers and interest rates without negatively impacting your credit score.

4. Apply for loan

Gather any information and documentation the lender will need before applying to ensure timely application processing. Once you have your documents handy, submit the loan application. Some lenders allow you to apply online, receive a quick decision and upload the supporting documents to issue final approval. But if you’re applying with a traditional bank or credit union, you may be required to visit a physical branch to apply, and it could take much longer to receive a lending decision.

5. Close loans and make payments

If approved, review the loan documents, get clarity on anything you don’t understand from the lender and sign on the dotted line. The lender will process the file for closing and disburse the loan proceeds. It’s up to you to pay creditors directly unless the lender offers direct payments to streamline the consolidation process.

Pros and cons of debt consolidation

Although a debt consolidation loan can provide some much-needed financial relief, it may not be the right move for everyone. Consider the pros and cons to make an informed decision.

Pros

• Predictable monthly payment. When consolidating your debt, you roll several balances into a single loan product. Debt consolidation loans typically have fixed interest rates. That means you’ll get one predictable monthly payment instead of paying multiple creditors each month, some with fluctuating interest rates.
• Shorten repayment period. You could get out of debt faster by consolidating the balances. This is particularly true with credit card debt, which only requires you to make a small monthly payment, mostly interest. With a debt consolidation loan, you’ll have a preset loan term that tells you exactly when you’ll reach the finish line.
• Save on interest. The average interest rate on personal loans is far lower than what is offered with credit cards. As of September 2023, the average credit card rate is just under 21 percent, compared to just over 11 percent for personal loans. Remember that the best interest rates on debt consolidation loans are generally reserved for borrowers with good or excellent credit scores.
• Improve credit. When you take out a debt consolidation loan, you get a hard inquiry that could dip your credit score by a few points. The upside is your credit utilization ratio will drop when you pay off your balances, possibly boosting your credit score. Your payment history, accounting for 35 percent of your credit score, will also improve as you make timely loan payments.

Cons

Unfortunately, there are also drawbacks to consider before applying for a debt consolidation loan.

• Loan fees. You could be on the hook for fees when taking out a debt consolidation loan. Some lenders charge an origination fee deducted from the total loan amount, reducing the amount of funds disbursed to you. Prepayment penalties may also be assessed if you pay off the loan early.
• Risk of overspending. If you’re undisciplined with your spending habits before taking out a debt consolidation loan, you risk digging an even bigger debt hole. So, it would be best to refrain from using credit cards once you’ve paid them off.
• Unaffordable. A lower credit score means you could get a higher interest rate on a debt consolidation loan than you currently pay. This also means your monthly payment could stretch your budget thin.
• Potential credit consequences. Your credit score could suffer if you can’t afford your monthly loan payments and default on the loan. You’ll have 30 days to bring the loan current, or the lender will likely report the delinquency to the credit bureaus. Late payments mean bad news for your credit score and linger for up to seven years, although the impact dwindles over time.

Alternatives to debt consolidation

After exploring your options, you may find that debt consolidation isn’t an ideal solution for you. Whether it’s due to your inability to qualify for a loan with attractive terms or you need to access a larger amount, there are alternatives worth considering.

Balance transfer credit card

These debt products come with an introductory, interest-free period – generally between 12 and 24 months. If you transfer high-interest balances to this card and pay them off before the promotional period ends, you’ll save a sizable amount in interest.

Home equity loans

Convert your equity into cash with a home equity loan or home equity line of credit (HELOC). Your home is used as collateral, so staying current on the monthly loan payments is essential to avoid foreclosure. You’ll also need a certain amount of equity in your home to qualify for a home equity loan product.

Cash-out refinance

A cash-out refinance is also used to pull equity out of your home. It lets you swap out your current mortgage with a new one for a larger amount, including the funds you withdraw. And, like a home equity loan, you risk losing your home to foreclosure if you fall behind on monthly loan payments.

Credit counseling

This service is offered mainly by nonprofits and involves restructuring your debts, often through a debt management plan (DMP) that comes with a setup and monthly maintenance fee. The credit counseling company will work directly with your creditors to negotiate lower interest rates and fee waivers to help you pay off the balances sooner. You’ll make one monthly payment to the credit counseling company, and they will also pay the creditors on your behalf.

Debt settlement

Debt settlement companies promote their services as an alternative to bankruptcy. They reach out to your creditors in hopes of settling debts for less than you owe and charge a settlement fee each time an agreement is reached. You could resolve your debts sooner using this approach. Still, the damage to your credit score is likely significant, as companies usually require you to fall behind on payments before settling your debt. Additionally, by settling your debts for less than the owed amount, lenders will see you as a high-risk borrower, limiting your access to affordable credit products in the future.

Bankruptcy

Bankruptcy should be used as a last resort to get a handle on your debt. Depending on the type of bankruptcy filing, the debts will be discharged or reorganized into a payment plan in federal court. Consult a bankruptcy attorney to determine if this method will best resolve your debt.

Bottom line

If you’re considering a debt consolidation loan to get out of debt sooner and save money, weigh the advantages and disadvantages it offers before applying. You should also understand the lending process so you’ll know what to expect and can take the necessary steps to boost your approval odds. But if you find that a debt consolidation loan isn’t right for you, other alternatives could be more suitable.