Managing all of your debts, with multiple due dates, interest rates and minimum payment amounts, can be a lot to keep track of. Missing one payment can hurt your credit score and your chances of borrowing money in the future.
That’s why rolling all your monthly bills into a single payment with a new personal loan for debt consolidation can be a good way to simplify your financial life, keep your credit strong and make it easier to repay what you owe each month. Of course, you should continue to pay all your bills on time until you’ve simplified the payment setup with your new loan.
What is a personal loan for debt consolidation?
Using a personal loan to consolidate debt is when you pay off all your credit cards, loans and other debt with the loan funds and then make one manageable payment toward your personal loan until it’s paid off.
If you have many types of debt, a personal loan can help you keep them current. Falling behind on any of your payments, whether for a credit card or student loan, can crush your credit score. It could also hinder your chances of borrowing money in the future.
Debt consolidation loan vs. personal loan
While it’s often referred to by its own name, a debt consolidation loan is simply a personal loan that’s used to consolidate debt.
A personal loan is a lump sum of money that can be used for a variety of purposes, such as making a large purchase. You repay the loan in monthly installments for a set amount of time. Personal loans are usually unsecured, meaning they don’t have any collateral backing them up.
Pros of debt consolidation with a personal loan
There are several benefits to consolidating debt with a personal loan that make this an attractive option:
- One monthly payment: It can be difficult to keep track of multiple monthly debt payments. A debt consolidation loan simplifies your finances and allows you to make a single monthly payment.
- Lower interest rates: While personal loans often come with higher rates than secured debt, they may have lower rates than credit cards.
- Pay debt off faster: With a lower interest rate, you may be able to save money and pay your debt off sooner with a personal loan.
- Improve your credit score: Using a personal loan to consolidate debt can improve your credit score by increasing your available credit, which reduces your credit utilization ratio.
Cons of debt consolidation with a personal loan
While a debt consolidation loan has its perks, there are also downsides you should consider:
- Potentially high interest rates: Personal loans usually have lower interest rates than credit cards, but for borrowers with poor credit, personal loan rates can exceed 30 percent.
- Extra up-front costs: When you take out a personal loan, you may be subject to loan origination fees. Other common fees can include prepayment penalties and late payment fees.
- Could encourage more spending: Debt consolidation doesn’t get to the root problem of why you got into debt. If you consolidate your credit card debt with a personal loan, you might be encouraged to start racking up new debt.
When should you get a personal loan for debt consolidation?
Having high-interest debt, such as credit card debt, might make you a good candidate for a debt consolidation loan since personal loans tend to have lower interest rates than credit cards. You might be a good candidate for a personal loan if:
- You have strong credit: The better your credit, the more likely you are to qualify for a loan at the lowest interest rate The lower your interest rate, the less you have to pay on top of the money you borrow.
- You have significant — but controlled — debt: If the amount of your debt is large but you’re able to make at least minimum monthly payments, a personal loan might work best for you.
- Your spending is in check: A personal loan won’t help if you don’t have a handle on your spending. In fact, it could put you in even more debt. Before you get a personal loan, review your finances to make sure you can afford the loan and pay your debt.
You can still qualify for a personal loan if you don’t have great credit, but you might face higher interest rates. If the personal loan rates you’re offered are higher than what you’re paying on your debt now, try alternative methods for tackling your debt. Once your credit improves, you may qualify for lower interest rates on debt consolidation loans.
Other ways to consolidate debt
If a debt consolidation personal loan won’t work for you, there are a few ways to consolidate debt, including:
Home equity loan
If you own your home and owe less on your mortgage than the house is worth, you may be able to take out a home equity loan and use it to pay off your outstanding debt. A home equity loan is a type of second mortgage that allows you to borrow against your home’s equity. You can use the lump sum you receive from your home equity loan to pay off all your outstanding debt and then make a single payment on the new loan each month.
For home equity loans, your home is collateral. As a result, the lender views your loan as less risky, which means interest rates are typically lower compared to unsecured loans such as personal loans. But keep in mind that if you fall behind or fail to make payments on your home equity loan, you could lose your home. Calculate your home’s equity to see if you’d qualify to borrow enough to cover your outstanding debt.
Balance transfer credit cards
If you have a few credit card balances you want to manage, you could try a balance transfer credit card. Many cards offer 0 percent APR for a set amount of time, usually ranging from 12 to 21 months.
This is a good way to move all your existing credit card debt into one manageable payment each month. Keep in mind that if you have a lot of credit card debt, you might not get approved for a balance transfer that’s the full amount you need to move over. That means you could be paying off your new card balance as well as any cards that couldn’t get moved over.
If you don’t pay a balance transfer credit card off before the 0 percent APR period ends, the card issuer starts charging interest.
Debt payment strategies
If you don’t qualify for a new loan or credit card transfer, you might have to manage your debt in a different way. If you haven’t done so already, start by organizing your debt on a spreadsheet. Write out every lender you owe money to, your current interest rate, how much you owe and your monthly due date. From there, you can try a couple debt management methods:
- Debt snowball: This method focuses on paying your smallest debt off first. While making minimum payments on every other debt you have, you put all your extra cash toward the debt with the lowest balance. Once that’s paid off, you then focus on putting all your extra money toward the next-lowest balance. Do this until all your debt is paid in full. The upside is that you’ll see results fast. The downside is that you might end up paying more in interest on other debt that charge higher rates.
- Debt avalanche: This method focuses on paying off the debt with the highest interest rate first. You make minimum payments on all your other debts, and then put all your extra cash toward the debt with the highest interest rate. Do this until the debt is paid off, and then move on to the debt with the next-highest interest rate until all your debt is paid in full. While you might save more money by paying higher-interest debt off first, you might not see results as fast as you would with the debt snowball method.
The bottom line
A personal loan could be a great way to consolidate your debt, but it’s not necessarily the right method for everyone. Review your debt situation and see if a personal loan would work best. If not, try methods such as a home equity loan or balance transfer or a debt management strategy.