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Using a personal loan to consolidate debt: a guide

consolidate debt with personal loan

Consumers may use personal loans to consolidate debt. These debt consolidation loans involve taking various balances (from credit cards, other loans, etc.), and combining them into a single loan with one monthly payment. 

Are you dealing with some financial hardship and looking for convenient solutions? If so, it may be a good idea to consolidate debt with a personal loan. Personal loans can help you take care of existing debts while also providing competitive rates, convenient repayment terms, and more.

Here, you will learn about the best debt consolidation loans you can take advantage of so you can get your finances back on track! 

What Is a Debt Consolidation Loan?

It’s important to distinguish the difference between a personal loan vs. debt consolidation. A debt consolidation loan is a form of funding that takes multiple debts and combines them into one monthly payment. Instead of keeping track of multiple balances and being charged interest over and over again on all your debts, you can consolidate everything into one convenient loan. That way, you can make one payment a month that takes care of a plethora of expenses. Depending on your financial situation, getting a debt consolidation loan may be an extremely wise financial decision. According to CNBC, the number one reason why consumers with high credit scores take out personal loans is to consolidate debt.1 

Unsecured Personal Loans vs. Secured Personal Loans

Most funding types can be divided into two categories: secured or unsecured. A secured loan is funding that requires collateral, while an unsecured loan (also referred to as unsecured debt) is funding that does not require collateral. Collateral is a piece of property with equity that borrowers can use to secure loan funds. Common pieces of property used as collateral for secured loans are vehicles and real estate. Borrowers who own a vehicle may use the title as collateral for car title loans, and borrowers who own a home or another type of real estate may use the equity of the property as collateral for mortgage loans. 

While borrowers who take out unsecured loans do not have to put any property up for collateral, lenders tend to rely more on credit scores and credit history when it comes to approval for these types of loans. However, don’t be discouraged if you have less than perfect credit, there are still great unsecured bad credit loan options available for debt consolidation! 

What Kinds of Debt Can I Pay With a Consolidation Loan 

People can use debt consolidation loans for consolidating credit card debt, or to organize other debts like: 

  • Student loans 
  • Auto loans 
  • A home equity loan 
  • High-interest debt like online payday loans
  • Medical bills 
  • Funeral expenses 
  • Unexpected traveling costs 
  • Financial emergencies 

What To Consider When Researching Loans

AspectDetails
Loan Term Options– Short-term (1-3 years)
– Medium-term (3-5 years)
– Long-term (5+ years)
Typical Loan Amounts– Ranges from $1,000 to $50,000 depending on lender and borrower’s creditworthiness.
Prepayment Penalties– Some lenders charge for early repayment.
– Others do not have prepayment penalties.
Loan Approval Time– Varies from 24 hours to a few weeks.
Impact on Debt-to-Income Ratio– Consolidation can lower ratio by reducing number of debt accounts.
Loan Disbursement Time– Typically within a week of approval, depending on the lender.
Eligibility Criteria– Credit score requirements vary by lender
– Income stability
– Debt-to-income ratio
Typical APR Range– Varies widely, from around 6% to 36%, based on credit score and lender.
Secured vs. Unsecured – Most are unsecured, not requiring collateral.
-Secured options may offer lower interest rates.
Lender Types– Traditional banks
-Credit unions
– Online financial institutions
Loan Usage Restrictions – Generally no restrictions, but intended for debt consolidation.
Credit Report Inquiry– Hard inquiry typically required, which may affect credit score temporarily.
Online Application Availability. – Most lenders offer online applications for convenience and faster processing.
Disclaimer: Please note that the information provided in this chart is for general informational purposes only and may vary depending on individual circumstances and specific lenders. It is important to conduct thorough research and possibly consult with a financial advisor to understand how these factors apply to your personal financial situation.

How To Use a Personal Loan for Debt Consolidation 

Below is a step-by-step process on how you can make the most of debt consolidation loans. 

Using a Personal Loan as a Debt Consolidation Loan: Step One | Calculate Your Total Debt

This first step of debt consolidation is to calculate how much debt you have in total. To do this, make a list of all your loans, credit card balances, as well as any past due balances on any existing debt, and add up the totals. The amount you come up with is your total amount of debt. 

Once you know how much debt you need to pay off, you can start thinking about short-term financing vs. long-term financing. If you have a few thousand dollars or more to pay off, you may want to consider getting a long-term loan plan. That way, you can space out your monthly payments and not be stressed while paying back your debt consolidation loan. 

Using a Personal Loan as a Debt Consolidation Loan: Step Two | Check Your Credit Score

After you know how much debt you need to take care of, you want to next check on your credit score. Your credit score will be a great guide to help you decide what kinds of loan products you should consider. For example, if you have a lower credit score, you may have a more challenging time getting a debt consolidation loan with a bank and would be better off going with a bad credit private lender. But, if you have a higher credit score, you most likely will have an easier time finding approval on loans with a high loan amount and convenient repayment terms from just about anywhere. 

Using a Personal Loan as a Debt Consolidation Loan: Step Three | Research Personal Loan Lenders 

Once you know what type of loan you are qualified for, it’s time to compare lenders and see who offers personal loans that best suit your budget. Review different lenders and the loan amounts, interest rates, loan terms, and fees that come with their loan products. 

If you want flexibility in your repayment schedule, make sure to go with a lender who does not tack on prepayment penalties. A prepayment penalty is a fee charged to borrowers who make their monthly loan payment before the designated due date. Or, some lenders may charge origination fees. A loan origination fee is a charge some lenders require at the time of signing a loan contract. 

Once you’ve narrowed down your search to a few select lenders, give each of them a call and discuss your personal financial situation and debt repayment goals. The loan agent may be able to give you helpful advice or information as to whether their loan product will be a good fit for you or not. 

Using a Personal Loan as a Debt Consolidation Loan: Step Four | Compare Interest Rates 

Interest rates are one of the most influential factors of a loan. The interest rate of a loan determines how long it will take for the borrower to pay off their loan balance as well as how much they will end up paying for their loan in total. If you have a high-interest rate, you may have to take years to pay off your balance and find that you’ve spent hundreds of dollars or more than your original loan amount! To make sure you get the most beneficial loan deal for yourself, pay close attention to the kinds of interest rates many lenders are willing to offer you. 

Also, consider what kind of interest rate may work best for you. Some common types of interest you may come across during your search for a debt consolidation loan are: 

  • Variable rate installment loans 
  • Fixed-rate personal loans

Variable rates mean your interest charges may change from month to month. While this may be convenient some months when rates are lower, you must also be prepared to pay a bit more if your rates go up. Fixed rates on a loan mean the interest rate stays the same throughout the life of the loan. A fixed interest rate may be an excellent option for debt consolidation borrowers looking to keep their finances steady and organized

Using a Personal Loan as a Debt Consolidation Loan: Step Five | Finalize Your Debt Management Plan 

Once you’ve found an appropriate lender with the right loan product for you, fill out an application. Many online lenders will have a convenient virtual application that you don’t even have to leave your house in order to complete! 

If your application is approved, the lender will next ask for a few documents. Those documents may be: 

  • A government-issued photo ID 
  • Proof of income 
  • Proof of residency 
  • Bank account information 

After your lender processes your documents, they’ll draw up a loan agreement for you to sign. Read your contract and ensure everything makes sense, then sign and receive your money. From there, you can take care of your debt consolidation needs! 

What Are My Options for Debt Consolidation? 

Depending on your financial situation, you may be able to find debt consolidation loans with a financial institution like: 

  • Banks
  • Credit unions 
  • Online lenders 
  • Private lenders 
  • Direct lenders 

Debt Consolidation Loans vs. Debt Settlement 

Depending on your financial situation, you may be contemplating between debt consolidation or debt settlement. As discussed, debt consolidation involves combining multiple debts under one debt management plan. While borrowers can save money by using personal loans for debt consolidation, they are still ultimately responsible for paying off all of their balances in total. Keep in mind that debt consolidation can take time but won’t have nearly as much of a negative impact on your credit history that settling debt will. 

Debt settlement involves working with a settlement company and negotiating a payoff amount with a borrower’s various creditors. People who settle their debt are typically utilizing the process as a last resort when they have absolutely no other way of meeting their debt payment obligations. While debt settlement can be a faster way to get rid of debt, this choice may negatively affect your credit report for seven years or more. 

Other Tips for Debt Consolidation 

Check out some helpful tips below on consolidating debt. 

Pay More Than Your Minimum Amount Due

If you can, pay a bit more than the amount due on your monthly debt payments. By paying more than your minimum amount, you may not only pay off your loan early but save money on interest rate charges in the process! 

Keep Your Finances Organized 

When consolidating debt, it’s essential to keep your ingoing and outgoing finances in order. If you have not created one already, make a monthly or yearly budget. You also may want to perform a soft credit inquiry and check your credit reports at least once a month to monitor your progress. 

Try Balance Transfer Credit Cards / Credit Card Balance Transfer

A balance transfer credit card is a line of credit used to consolidate credit card debt. This kind of card is designed to help people save money on interest rates. However, balance transfer credit cards may not be the best choice if you have an extensive amount of credit card debt. In a situation like this, you would most likely be best off taking care of your credit card debt with debt consolidation loans. 

Utilize Debt Relief Services 

If you are having trouble getting your finances back in order, consider working with a credit counseling agency. These agencies offer both free and paid services that can help you learn more about finances and how you can improve your overall situation. 

FAQ: Personal Loans and Consolidating Debt

What impact does consolidating debt with a personal loan have on my credit score?

Consolidating debt with a personal loan can initially dip your credit score due to the hard inquiry from the loan application. However, over time, it can improve your score by lowering your credit utilization ratio and establishing a consistent payment history.

How does a personal loan for debt consolidation affect my monthly payments?

A personal loan for debt consolidation often leads to a lower monthly payment compared to the combined payments of your individual debts, especially if you secure a loan with a lower interest rate or a longer repayment term.

Can I still get a personal loan for debt consolidation if I have a low credit score?

Yes, it’s possible to get a personal loan for debt consolidation with a low credit score, but you might face higher interest rates. Some lenders specialize in loans for those with less-than-perfect credit.

What should I consider when comparing interest rates for personal loans?

When comparing interest rates, consider the APR (Annual Percentage Rate), which includes the interest rate and any additional fees. A lower APR means a lower cost of borrowing.

How does consolidating debt with a personal loan influence my credit utilization ratio?

Consolidating credit card debt into a personal loan generally lowers your credit utilization ratio, as the installment loan doesn’t count towards this ratio. A lower credit utilization ratio can positively impact your credit score.

Is there a difference between a balance transfer and a personal loan for debt consolidation?

Yes, a balance transfer involves moving debt from one or more credit cards to another card, often with a lower interest rate. A personal loan consolidates multiple debts into a single loan. Balance transfers often come with a balance transfer fee.

How quickly can I improve my credit score after consolidating my debts with a personal loan?

Improvement in your credit score can be seen within a few months, as you reduce your credit utilization ratio and make consistent, on-time payments, which are reported to credit bureaus.

What are the risks of using a personal loan to consolidate debt?

Risks include potentially higher interest rates than your current debts, the temptation to use freed-up credit lines, and the possibility of extending the debt period if you choose a loan with a longer term.

How do personal loans for debt consolidation show up on my credit report?

Personal loans are reported as installment loans to credit bureaus. Timely payments can positively affect your credit score, while late or missed payments can have a negative impact.

Can consolidating debts with a personal loan lead to a lower interest rate compared to credit cards?

Often, yes. Personal loans typically have lower interest rates than credit cards, especially if you have a good credit score, which can lead to significant savings over time.

What factors should I consider before choosing to consolidate my debts with a personal loan?

Consider the interest rate, loan term, monthly payment amount, any fees associated with the  loan, and how these terms compare to your current debts.

How does a lower monthly payment from a debt consolidation loan affect my long-term financial health?

A lower monthly payment can ease your immediate financial burden, but it’s important to consider the total interest paid over the life of the loan. Sometimes, lower payments can mean paying more in total interest.

Are there any alternatives to using a personal loan for debt consolidation?

Alternatives include balance transfer credit cards (watch out for balance transfer fees), home equity loans, credit counseling services, and debt management plans. Each option has its own pros and cons and should be considered based on your individual financial situation.

CreditNinja’s Thoughts on Debt Consolidation Loans

Borrowers have many debt consolidation options to pick from, but not all loans are the same. When looking for personal loans for debt consolidation, CreditNinja urges everyone to research different lenders and see what kind of interest rate, loan term, and funding amount they can offer you. 

Check out the CreditNinja blog for more free resources on improving your finances, bad credit funding options, and more! 

References:
1. The Average Amount Of Debt High-Credit Score Borrowers Consolidate | CNBC
2. Best Debt Consolidation Loans | Forbes Advisor
3. Dealing with Debt | USAGov

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