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Personal loan vs debt consolidation fully explained

personal loan vs debt consolidation

When researching financial solutions for debt payoff or loan options, you may come across personal loan and debt consolidation loan options. Depending on your financial situation, these loan types and the process to get them definitely have their differences, along with advantages and disadvantages. Continue reading to learn more about both personal loans and debt consolidation loans/the debt consolidation process.

How Do Personal Loans Work?

Personal loans are a type of unsecured loan that is repaid in monthly installments. Secured personal loans are available, but they are not the norm. These loans generally have fixed interest rates and equal monthly payments until the loan is paid back. Personal loans are available in various amounts and repayment terms. And the funds from personal loans can be used for all sorts of expenses, making them a good option for almost any expense. 

You can find personal loans with banks, credit unions, and private lenders online or in person. With banks and credit unions, you will likely need a good credit score for personal loans, while online lenders will likely allow more flexibility with credit score and approval in general. When you take out most personal loans, you usually have to start repayment 30 days after getting your funds.

The Application Process With a Personal Loan

If you haven’t applied for a personal loan before, you may be unsure about what the application process looks like. Here is a step-by-step guide to that process with a personal loan: 

Apply for Pre-Approval With Personal Loans

Once you find a few lenders you want to work with for a personal loan, you need to apply for pre-approval. Lenders will ask about your income and your credit score. Once pre-approved, you’ll get a rough idea of what loan terms and the amount you will get. 

Compare Your Personal Loan Options 

Once you have pre-approval with a handful of loan lenders, you can decide on the best option. You’ll want to find a loan that has a competitive interest rate, flexible repayment terms, a manageable loan term, and a loan amount that fits your needs. 

Send in Documents for Pre Approval With Personal Loans

Once you find a lender you want to work with, you’ll have to send in some documents. Most lenders will ask you to prove your identity and your income and okay a hard credit check. With this step, if you are approved, you’ll know the exact loan amount, interest rates, and repayment terms. 

Once Approved, Get the Funds

Once you are approved for a personal loan, all you’ll have to do is sign the loan contract and get your funds. In most cases, a lender will have the funds sent to a bank account, mailed to you as a check, or have you pick up the funds at a location.  

How Does Debt Consolidation Work?

Debt consolidation is the process of paying off multiple debts by using a single loan. Debt consolidation loans are the loan options that make doing so a possibility. The debt consolidation loan process can be beneficial if you are juggling several high-interest loan options. With this process, you’ll only have one monthly payment to worry about, and with the right debt consolidation loan, you should get a better interest rate than the current debts you may have. The majority of borrowers (69%) say their finances have improved since consolidating their debt.1 And when done right, your finances could improve also.

Repayment, loan terms, and the interest rate for a debt consolidation loan will depend on the type of loan you take out. All kinds of loans and credit accounts can be used to consolidate debt, but you’ll find the following options are the most helpful: 

A Balance Transfer Credit Card for Consolidating Debt 

Balance transfer credit cards are an excellent tool for debt consolidation because they can offer things like low or no interest for an introductory period. Most of the time, people pay off credit card debt with a balance transfer card, but you may be able to consolidate other types of debt with one of these options. Keep in mind that you may need a good credit score to be approved for a balance transfer card. 

Specifically, Debt Consolidation Loans

Although almost any loan can be considered a debt consolidation loan, you’ll find loan options specifically tailored for this process, thus the name “debt consolidation loans.” If you can qualify for one of these loan options, you’ll see a relatively low interest rate and flexible loan terms, especially if you have a good credit score. 

Steps To Get a Debt Consolidation Loan

The process of consolidating debt is pretty straightforward; you’ll have to apply for a new loan and then use it to pay off your existing debt. Still, if it’s your first time doing so, you may need a step-by-step explanation. Here is the process: 

Pick a Loan You Want To Borrow Money from and Find Lenders 

The first step you’ll need to take is to figure out what kind of loan you want. Once you decide on that, you can try and find lenders for debt consolidation. Applying for pre-approval with one of these loans is similar to how things work with a personal loan. A lender will ask about our income, credit score, and ability to repay the loan. 

Get Pre-Approved and Compare Your Loan Options 

Once you have pre-approval with lenders, you can compare your loan options. With debt consolidation loans, you’ll want to make sure you can borrow enough funds to pay off your existing debts. Also, pay close attention to the interest rate, as you don’t want to borrow a more expensive loan when the goal is to get rid of existing high-interest debt. 

Once Approved for the Loan, Get the Funds and Pay Off Your Existing Debts 

The next step is to move forward with final approval; you will need several different documents that prove your income and identity and be okay with a hard credit check to pull your credit report. Once you get final approval, you will get the funds you need. You can then pay off any debt you may have, including existing credit card debt, a home equity loan, a personal loan, a payday loan, or any other credit account you have. 

Begin Repaying the New Loan

Once all your existing debt is paid off with your new loan, the great news is that you will only have a single monthly payment rather than multiple loan payments to juggle! Usually, after 30 days, you will need to start repaying your new loan for debt consolidation. One way to make this easy is to automate your monthly payments. Not only will a consistent monthly payment look good for your credit score, but it will also help you save money on late fees. 

Debt Consolidation vs Personal Loan 

You can use both a debt consolidation loan option (either a debt consolidation loan or a balance transfer credit card) and a personal loan for debt consolidation. Both options have pros and cons when using them for this purpose. Here is a breakdown of each option:

Loan TypePersonal LoanDebt Consolidation Loan
EligibilityAvailable even with bad credit score, with the right lendersTypically requires a decent credit score
Income RequirementMay not require a lot of incomeOften requires a stable income source
Loan AmountMay not offer a high loan amountPotential for a larger loan amount
Co-signer OptionAllows adding a co-signer or co-borrowerUsually not necessary
PurposeVersatile loan for various financial needsPrimarily used for consolidating debt
RatesRates can vary widelyTypically offers competitive rates
Repayment TermsTerms may vary, shorter in some casesLonger repayment terms available
Debt ConsolidationNot specifically designed for debt consolidationIdeal for consolidating multiple debts
Additional InformationEvaluate if it’s the right option for your needsBest choice for debt payoff and large loans

With personal loans, you will likely find several options (even with a bad credit score). However, if you don’t have a lot of income or a low credit score, you may not get the loan amount you need with a personal loan. You can add a co-signer or co-borrower to the loan to help you get a higher loan. 

With a debt consolidation loan, you will likely find the best deal for debt payoff and longer repayment terms (which can be helpful when paying back a large loan). If you aren’t pursuing one of these loans specifically for debt consolidation, you’ll find more information on whether each loan option is the right option for you. 

Are Debt Consolidation Personal Loans Right for Me?

A personal loan will work well for you if you have multiple small expenses, are facing an emergency, or need some extra cash for extra expenses. As mentioned above, personal loan options can be used for almost any expense, making them a good option for nearly any kind of expense. Even with bad credit, you should be able to borrow from one of these loan options. 

And so, if you need money for various expenses, bad credit loans may be right for you. 

Is Debt Consolidation the Right Option for Me?

Deciding on a debt consolidation loan largely depends on your financial situation and goals. These loans are primarily designed for those who are grappling with multiple forms of high-interest debt and are looking for a streamlined way to manage them. Here’s what you should consider:

Purpose

The primary objective of a debt consolidation loan is to consolidate multiple debts into one loan, usually at a more favorable interest rate and a lower monthly payment. This means that if you have several credit card balances, personal loans, or other forms of debt, debt consolidation loans offer sufficient funds (is approved) to pay them off, effectively replacing multiple payments with a single monthly payment.

Interest Rate

Debt consolidation loans often come with competitive interest rates, especially when compared to high-interest credit cards. This can translate to substantial savings over the life of the loan.

Budgeting

A single monthly payment can simplify your budgeting process. Instead of tracking and managing various payments with different due dates, you’ll have just one payment to consider.

Other Expenses

While debt consolidation loans are primarily intended for paying off debt, it’s essential to understand that they may not be suitable for other expenses or needs. Lenders often release loan funds directly to your creditors, ensuring the loan is used for its intended purpose. This means you might not receive the loan amount in your account to use at your discretion.

Long-term Commitment

It’s important to remember that by consolidating your debts, you’re not eliminating them – you’re restructuring them. Ensure that you’re prepared for the commitment of paying off the new loan and that you have a plan in place to prevent accumulating new debts.

Other Strategies To Repay Debt

A loan isn’t the only way to pursue debt payoff or follow a debt management plan. Budgeting, debt payoff strategies, and even apps can help you get started to become debt-free. Budgeting can help you get a picture of your expenses, income, and debt to help you figure out the best strategy to make your money work for you. And that can include helping you figure out ways to pay off debt. Or you can use one of the many debt payment strategies, such as the avalanche or snowball method. There are also apps that can link to your financial accounts and help you come up with a personal debt repayment plan. And so, as you can see, personal loans and debt consolidation loans are not your only options if you want to pursue debt payoff. 

FAQS

What is the difference between secured and unsecured personal loans?

An unsecured personal loan does not require collateral, meaning the loan is offered based on your creditworthiness and credit report. In contrast, a secured loan might involve assets like a home, making it akin to home equity loans. If there’s a default on the secured loan, the lender might claim the asset.

Are there any fees associated with personal loans or debt consolidation loans?

Indeed, when you consolidate debt or borrow personal loans, lenders might charge origination fees, application fees, or penalties for paying the loan early. Always review the terms to ensure it’s cost-effective.

How does my credit score affect my loan interest rate?

Your credit score plays a pivotal role. Those with high credit scores are generally offered lower interest rates as they pose less risk. Conversely, if you have poor credit, you might face higher rates or loan denial.

Can I consolidate student loans with a debt consolidation loan?

It’s possible to use a debt consolidation loan for student loan debts. However, be cautious. Federal student loans have specific benefits that you might lose when opting for private debt consolidation.

What happens if I miss a payment on my debt consolidation loan or personal loan?

Missed payments can lead to late fees, increased interest rates, and a dent in your credit score. If you foresee issues with on-time payments, contact your lender promptly. They might provide solutions.

Can I pay off my personal or debt consolidation loan early?

Many lenders allow borrowers to clear their debt consolidation loans or personal loans ahead of time. However, always check for prepayment penalties to ensure you save money in the process.

What should I consider when choosing between a balance transfer card and a debt consolidation loan?

When looking to alleviate credit card debt, weigh in factors like the debt amount, interest rates, introductory periods, and any associated fees. While balance transfer credit cards can offer low or zero interest initially, rates can surge post the promotional phase. When borrowing money through a loan option such as a personal loan for debt consolidation, you usually don’t have to worry about changing interest rates, even if it is a secured personal loan.

How can a debt consolidation loan impact my credit score and credit history?

When you take out a debt consolidation loan, it can have several effects on your credit score. Initially, applying for a loan can cause a temporary dip in your score due to a hard inquiry into your credit history. However, once you start using the loan to pay off other debts, it can improve your credit utilization ratio—a key factor in credit score calculations. Following consolidation, 68% of consumers saw their credit scores improve by more than 20 points.2

If you maintain consistent monthly payments on your new loan and avoid accumulating more debt over time, it can have a positive effect on your credit score. It’s essential, though, to manage the loan responsibly to ensure your credit score benefits in the long run.

The Bottom Line With CreditNinja

Understanding the dynamics of personal loans versus debt consolidation can be a gateway to smarter financial decisions. Whether you’re grappling with a series of expenses or attempting to simplify multiple debts into a single payment, there are tailored solutions for your financial scenario. At CreditNinja, we advocate for informed choices that align with your financial goals. Remember, loans aren’t just about borrowing but strategically navigating your financial journey. Always weigh the pros and cons, and when in doubt, consider seeking professional advice. Dive deeper into our resources for some of the basics!

References: 

  1. Survey: Debt Consolidation Pays Off for 69% of Borrowers | Personal Loans and Advice | U.S. News
  2. Consolidation and Credit Scores | Transunion

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