Consumers can find loans to consolidate debt via many different financial products. Depending on your credit history and financial situation, you may benefit most from a Personal loan, secured loan, or other type of funding. But how do you know which kind of loan will work best for you?
Here you will learn how to find some of the best debt consolidation loans available and other financial alternatives you may consider to get rid of your debt.
What Is Debt Consolidation?
Debt consolidation loans are a way for consumers to combine multiple debts into one loan and one monthly payment. Borrowers with several loans or other forms of debt may end up paying hundreds of dollars or more in interest rate charges, which could be significantly reduced with a single debt consolidation loan. In addition to saving money on interest rate fees, debt consolidation loans can also help borrowers pay off their total debts faster. Paying off debts could come with many benefits, including:
- Increase in credit score.
- More spare income in your budget.
- Less financial stress.
What Types of Loans Work Best for Consolidating Debt?
There are several types of lenders and products that can help consolidate debt. Here are some examples: .
One of the most common ways to consolidate debt is with personal loans. Borrowers can use personal loan funds to cover just about any expense–whether it be medical costs or for catching up on some past due bills.
Interest rates, terms, and loan amounts for unsecured personal loans may rely all or in part on the borrower’s credit score, depending on the lending product and financial institution they choose to work with. There are also online lenders for bad credit who may be able to help low-credit borrowers find a personal loan for debt consolidation.
Home Equity Loan
If you own a home, you may be able to utilize its value for a home equity loan. Home equity loans are a type of secured loan that uses the borrower’s real estate as collateral. Since the value of homes and real estate properties is usually relatively high, home equity loans may come with high funding amounts.
Another way to get cash to consolidate debt is with a 401k loan. A 401k is a retirement account that many employers offer. Employees can contribute funds to their 401k accounts, and employers will often match all or part of those contributions. Account holders may also borrow money from their 401k accounts before retirement.
Wondering how a 401k loan may affect your credit report and credit score? The good news is that 401k loans may not have as big of an impact on your credit as other types of funding. Since a 401k account is essentially your retirement savings, taking money out is like borrowing money from yourself. This means that borrowing money from your 401k may not necessarily put you in debt, but rather it will reduce the amount of savings you have. However, keep in mind that if you default on a 401k loan, the forgiven amount may be considered taxable income.
Balance Transfer Credit Card
If your big issue is credit card debt, you may benefit from a balance transfer credit card. A balance transfer card is a type of credit card refinancing that allows consumers to take multiple balances and combine them onto one card. When it comes to personal loans and a balance transfer, the difference is that a personal loan is designed to consolidate various types of debts.
In contrast, balance transfer credit cards are meant to consolidate credit card debt only.
Signs that a balance transfer credit card may be a good idea for you are:
- You are carrying balances on several high-interest credit cards.
- You have a manageable amount of credit card debt you can pay off in approximately one year or less.
Alternatively, you may not find balance transfer credit cards helpful if:
- Your existing credit card debt could be paid off in a few weeks or so.
- You have a massive amount of credit card debt, in which case a debt consolidation personal loan may work better.
Debt Traps To Avoid When Trying to Consolidate Debt
Not all loans are created equal when it comes to successful debt consolidation. Below is more information on some types of loans you may want to avoid when trying to consolidate your debt.
A payday loan is a type of cash advance loan designed to assist borrowers through very short-term financial emergencies. Payday loans often come with high rates and short terms, making them an ill-suited financial product for consolidating large amounts of debt.
Monthly debt payments for payday loan borrowers who don’t pay off their entire balance within about two weeks could get so high that making minimum payments each month is not enough to reduce the balance. Because of the outrageous interest rates that typically accompany payday loans, it is common for them to cause borrowers struggling with their finances to fall into a cycle of debt.
Car Title Loans
Car title loans, also called “auto title loans” or just “title loans,” are another type of short-term loan that usually comes with high rates. Title loans are secured loans, which means they require collateral. For title loans, borrowers are required to have their lender sign onto their free-and-clear vehicle title as a lienholder, giving the lender partial ownership over the borrower’s vehicle for the duration of their title loan. Since rates are so high and terms are so short for title loans, it is not recommended that consumers utilize them for major debt consolidation purposes.
How To Get a Debt Consolidation Loan
How do debt consolidation loans work? The process is much like getting any other type of loan. However, there are a few steps you can take to help make sure you find the best possible deal.
Calculate Existing Debt and Set a Debt Management Plan
To make the most of your debt consolidation loan, make sure it covers all your existing debts. To calculate your debt, go through your credit card balances, loan balances, and any past due balances you may have from bills or other expenses, as well as any other recurring payments you are making to pay off any debts. Then, compare that amount to your income. This comparison will inform you of your debt-to-income ratio.
If your total debt is well under your general income, you may not need a debt consolidation loan. Instead, you may benefit from creating your own repayment schedule and simply organizing your finances to naturally free up some room in your budget to pay off your debt. However, if your debt heavily outweighs your income, you may be able to pay off your debts faster with a consolidation loan.
Check Your Latest Credit Report
If you decide that getting a debt consolidation loan is the right choice for you, start your loan search off by checking your credit score. For many personal loan lenders, the credit history of their applicants plays a huge role in determining who receives approval. Most traditional lenders, like banks, may only accept applicants who have an excellent credit score. Becoming familiar with your credit report and credit score will help weed out lenders and financial products you may not qualify for. It may also help guide you toward lenders and products where you will have a better shot at loan approval.
Research and Prequalify
Once you have narrowed down your pool of available lenders, do some research on these lenders and the financial products and services they offer. You can call lenders and speak to a loan agent about interest rates, qualification requirements, and any documents you may need to provide during the approval process. Depending on your finances, you may even be able to get a prequalification offer right on the spot. In addition to talking with lenders and loan agents, you may also want to take a look at online reviews to see what kind of experience other borrowers had with a specific lender.
Compare and Negotiate Offers
Next, compare all the information you found. Which lenders can offer you the highest loan amounts, the lowest interest rates, or the most convenient monthly payment? If there is one lender offering you something another lender isn’t, you may be able to use one loan offer to negotiate and get a better deal on another offer!
Choose a Lender and Apply
The last step is to pick a lender and submit an application. Try to limit the number of lenders you apply with, to preferably just one. This is because submitting too many loan inquiries at once can end up harming your credit score, potentially making it increasingly difficult to find approval for debt consolidation loans in the future.
Should I Get a Co-Signer with My Debt Consolidation Loan?
A co-signer is a consumer with a healthy credit score and financial history who is willing to use their creditworthiness to help another consumer get a personal loan. Having a co-signer on a loan could help certain bad credit borrowers find debt consolidation loans for higher funding amounts or with lower interest rates.
While a co-signer will not usually have access to the approved loan funds (that will go to the original borrower), they will still be responsible for paying back the balance should the original borrower fail to make payments or default on the loan.
Debt Consolidation Loan Breakdown
When researching loans and comparing offers, make sure you get information on the following to make sure you find the best deal possible.
Different lenders may have varying requirements when it comes to approval. Many traditional lenders like a bank may require borrowers to have a minimum credit score in order to receive approval on a loan. Other lenders may accept borrowers with bad credit but may require them to have an active bank account so the lender can distribute funds via direct deposit. Lenders should be clear and upfront about their approval requirements. If you can’t find the information you need on the lender’s website, you should be able to call and speak with a loan agent to get the answers you need.
Interest rates are one of the most pivotal factors of any kind of loan, including debt consolidation loans. Typically, borrowers with a higher credit score will receive better rates, while those with credit on the lower side may have to deal with more expensive rates.
Ask each lender about what types of fees come with their loans. You will want to avoid unnecessary charges such as prepayment penalties. A prepayment penalty, or prepayment fee, is a charge some lenders impose on their borrowers if they try to make a loan payment before its due date or pay off their loan balance early.
Your loan amount should cover most, if not all, of the debt you are trying to consolidate. This is why calculating your debt before you apply for a loan is so important. It would be a shame to go through the hassle of applying for a debt consolidation loan only to find out you actually need more money to truly get rid of all your debt.
Your repayment terms will determine how long it will take you to pay off your debt consolidation loan. Keep in mind that shorter terms may result in higher monthly payments, while longer terms may give you lower payments but cost more when it comes to interest rates. At the end of the day, you want to make sure your terms allow you to have affordable monthly payments you can make consistently.
Some loans may come with perks like free financial resources or services. While perks aren’t always a necessity when it comes to getting debt consolidation loans, you may find them enjoyable or even be able to use them as leverage to get a better deal with another lender.
Customer service can really make or break your loan experience. When researching lenders and speaking with loan agents, pay attention to how they treat you. You should be taken seriously and feel like a priority. Never work with a lender who makes you feel uncomfortable in any way.
Pros and Cons of Debt Consolidation Loans
Is debt consolidation worth the effort? Before you apply for another loan to consolidate debt, consider the pros and cons.
PRO: Pay Off Debt Faster
Getting a debt consolidation loan may help reduce the amount of time it takes to pay off your debts. Paying off multiple loans individually can take time, especially if you have stretched out your terms to make your monthly payments more affordable.
PRO: Simplify Your Finances
Having many loans out at one time can get confusing and may also put you at risk of forgetting to make a payment. Instead of keeping track of multiple balances, a debt consolidation loan can simplify things and allow you to pay off debt with just one monthly payment.
PRO: Potential To Save Money Long-term
If you have multiple forms of high-interest debt, such as payday loans or title loans, combining those loans with debt consolidation can help you save significantly on interest rate charges over time.
PRO: Work Towards Improving Your Credit Score
Consistent payment history and reducing debts are two of the most important things you can do to improve your credit score. By getting a debt consolidation loan and successfully paying it off, you may see an improvement in your credit score the next time you pull a report.
CON: Possible Fees
With any type of loan, there are usually fees included. For example, almost every loan, including most debt consolidation loans, will come with origination fees. An origination fee is a charge many lenders require for writing your loan contract. Some lenders charge this fee separately from the loan, while others will include it in the loan balance.
CON: Takes Time
While debt consolidation loans can help you pay off debt faster, it isn’t always a quick fix and won’t change your finances overnight. However, consolidating debt is almost always a better alternative to paying off multiple high-interest loans individually.
CON: Won’t Resolve Poor Financial Habits
Debt consolidation may help you organize your current finances, but it won’t fix any bad habits you have that could end up harming your future finances. For example, if you have an issue with impulsive shopping and spending using your credit card, a debt consolidation loan from a few months ago won’t fix this. In order to get your finances back on track once and for all, you will have to develop healthy financial habits that you stick to consistently.
Alternatives to Debt Consolidation Loans
Debt consolidation loans aren’t the only solution when it comes to paying off your debt. Below are some other options you may consider.
Debt Relief Services
The government offers debt relief services on both a federal and state level. Depending on the severity of your debt and overall financial situation, you may qualify for some loan forgiveness or other financial aid services that can help you take care of your debt.
You may also be considering debt consolidation vs. credit counseling. Debt consolidation is the act of getting a loan to combine your debts, which you will then pay off. Credit counseling is receiving financial advice from a counselor, which may or may not lead to a debt consolidation loan.
To find a reputable credit counselor, look for agencies that have low fees and offer convenient and accessible services. Most reputable credit counseling agencies are also non-profit organizations, which generally means their priorities lay with helping people instead of earning money. You can also check with your state attorney general, a local consumer protection agency, and/or the U.S. Trustee Program to learn more information about a credit counseling agency you are considering.
You may be able to find some good counseling programs through institutions such as:
- Credit unions.
- Certain schools or universities.
- Professional finance managers for military personnel.
- U.S. Cooperative Extension Service branches.
Furthermore, reputable credit counseling agencies will most likely do the following:
- Give you free information on services before you accept any offer.
- Have a staff of accredited and certified credit counselors who were authorized via an outside organization.
- Offers a variety of financial services, including but not limited to budgeting advice, classes on managing debt, and other free educational resources.
- The agency will make sure you understand the details about any fees or charges included with their services before you agree to anything.
- The credit counseling agency should assist you as much as they can, even if you cannot afford the fees and charges.
Budgeting and Setting Financial Goals
You may also be able to solve your debt-related problems simply by creating a budget and organizing your finances. If you don’t have one already, create a budget that includes all your debt payments and recurring expenses like bills, groceries, etc. Once you have all your necessities identified, take a look at your bank account and see how you are spending your money.
Does all of your income go towards the necessities in your budget, or do you spend on non-necessities like going out for dinner and drinks or frequent shopping trips? Try to hone in on your budget and spend solely on the things you need. You may find that watching your spending habits is enough to leave extra money in your bank account that you can use towards paying off debts!
Bankruptcy (As a Last Resort)
When it comes to bankruptcy vs. debt consolidation, you will almost always want to choose to consolidate debt over declaring bankruptcy. When you declare bankruptcy, you are officially stating that you have no money and are unable to fulfill your current financial obligations and debts.
Many people think that declaring bankruptcy will give them a clean slate, but this action can also come with dire consequences. For example, declarations of bankruptcy may have a negative impact on your credit history that follows you around for years. Chapter 7 bankruptcy may stay on your credit reports for up to 10 years, while Chapter 13 bankruptcy may stay on your credit report for up to seven years from the filing date.
Debt Consolidation vs. Debt Negotiation
You may also find that debt negotiation can help you in your debt consolidation journey. Instead of applying for a loan, you can contact each of your creditors and try to negotiate a lower repayment amount. You may have to explain to your creditors why you need to negotiate your debt, and it’s important to know that your creditors may not honor your requests. Your creditors may also suggest an alternative solution, such as refinancing or reworking your existing loan in some other way.
Debt Consolidation vs. Debt Settlement
It’s also important to understand the differences between debt consolidation and debt settlement. Debt settlement involves talking to your creditors and either negotiating a lower repayment amount or discharging your debt altogether. With debt consolidation, you would still be paying back your total original debt amount.
Keep in mind that both debt negotiation and debt settlement may have a negative impact on your overall credit history. And so, debt consolidation may be a better option than these alternatives.
When Is a Debt Consolidation Loan a Bad Idea?
Sometimes, a debt consolidation loan may not be in the best interest of your overall finances. For example, if you have small loan amounts you can pay off quickly, a debt consolidation loan may not be the best idea for you.
Take a look at the balances of the loans you currently have out. If your balances are relatively small, say a few hundred dollars or less, then getting a debt consolidation loan may be overkill. It may be just as efficient to pay off each small balance individually. Although having multiple balances may seem stressful, the wait time and fees that come with many debt consolidation loans may make the effort of applying for another loan not worth it.
Signs That a Debt Consolidation Loan May Be a Good Idea
If any of these situations sound familiar, a debt consolidation loan may be the perfect financial solution for you.
You Could Qualify for a Lower Annual Percentage Rate (APR)
If you have been working on improving your credit score and credit history, you may be able to qualify for lower interest rates than you would have in the past. Many lenders depend on an applicant’s credit history when determining loan details like funding amounts, terms, and interest rates. Generally, borrowers with a low credit score will only qualify for higher rates, while borrowers with a better score may qualify for lower rates.
If you have several loans that were taken out before you developed a stronger credit history, they may have high rates that are costing you each month. Depending on your current score, you may be able to qualify for a loan with lower rates, allowing you to consolidate several high-interest loans into one affordable loan.
You Are Struggling To Keep Track of Loans and Payments
Multiple loans with different due dates can get tricky to keep track of, especially if you are working with a limited budget. If your balances aren’t too high, debt consolidation may make keeping track of your debt payments infinitely easier. Debt consolidation will mean being responsible for one debt payment a month.
You Want To Pay Off Debt Efficiently On a Set Schedule
With debt consolidation loans, there is only one monthly payment to keep track of. If you have several loans out, they may all come with different terms, rates, and even payment due dates. This can leave you feeling like you are drowning in debt and constantly making payments to no avail. Getting a debt consolidation loan can be a great way to simplify your payments and give you a set schedule that should result in you hopefully becoming debt free.
The Bottom Line: Finding the Best Debt Consolidation Loan
While debt consolidation loans aren’t an overnight fix for debt and won’t solve deeper financial issues like habitual overspending or impulse shopping, they can be a great way to organize your finances, improve your credit history, and possibly save money on interest rate changes.
Consumers can use personal loans and other types of funding for debt consolidation. To make sure you find the best deal on your debt consolidation loan, research lenders, compare offers, and have a general financial plan in mind before you submit an application.
What Is Debt Consolidation & What Are Your Options? | Debt.org
What do I need to know about consolidating my credit card debt? | Consumer Financial Protection Bureau
Best Debt Consolidation Loan Companies and Programs 2023 | Debt.org
How To Get Out of Debt | Consumer Advice