If you have multiple debt balances from credit cards, high-interest loans and other forms of debt, you may want to merge them into one payment. You can use a debt consolidation loan to combine them into one lower-interest loan. There are many options on the market, so it is important to understand what a debt consolidation loan is and how to find the best one for you.
Debt Consolidation Loans, Defined
A debt consolidation loan is a loan that you use to pay off the balance on your other debts. This allows you to make a single payment each month, typically with a much lower interest rate than your other debt balances. By consolidating your debt payments into one, you eliminate the risk of forgetting payments and can usually pay less over the life of your loan due to lower interest rates.
Qualifying for a Debt Consolidation Loan
To qualify for a debt consolidation loan, you will typically need to show:
- Proof of income. This is one of the most important factors in getting approved for a debt consolidation loan as it shows whether you can realistically pay the monthly installments.
- Credit history. Your credit history shows a lender that you have made consistent payments in the past so the lender can be reasonably certain you will continue this trend.
- Financial stability. Lenders want to know that you are not a high-risk borrower. Depending on how much debt you are consolidating and what the debts are for, they may ask for collateral such as home equity. This is more common for larger loans.
Applying for a Debt Consolidation Loan
Once you’ve decided that a debt consolidation loan is the best way for you to manage your debt, you will need to apply for a personal loan. If you have poor or average credit, you may still be able to obtain a personal loan. These loans often come with high interest rates, so be sure that as you shop around, you ensure that a consolidation loan will either help you decrease your monthly payment or decrease your overall interest rate. Here are a few steps to follow to get a debt consolidation loan.
Check your credit score
The first step to getting a personal debt consolidation loan is to know what your credit score is. If you have a good credit score, you will get better rates and terms on your loan. If you have a low credit score, you might want to take a few months to work on raising your score to qualify for better terms.
List your debts
Next, make a list of all the revolving debt balances you want to consolidate. You should list out the principal balance, the interest rate, and the monthly payment. This will help you understand how much you are paying each month, the total you will pay on them if you do not consolidate, and the amount you’ll need to take out to consolidate all of these loans.
Now that you know how much you’ll need to take out, you can compare the options available. You can shop around with online lenders as well as to inquire at local banks and credit unions to see what interest rates and terms you may qualify for. Some lenders may let you pre-qualify to see what terms and rates you will qualify for without pulling a hard credit inquiry, which can impact your credit score.
Apply for a loan
Finally, you will apply for the loan that best fits your needs. Make sure you understand the details of the loan by reading the fine print and asking your lender any relevant questions. Once you’ve applied for the loan and been approved, you will sign the paperwork to close on the loan. Now, you’ll have one monthly payment to make. This payment may be less than what you had been paying on your debts each month before.
Debt Consolidation Loans: Pros
If you have multiple debt payments to make each month then a debt consolidation loan might be the best option for you. Here are some of the benefits of using a personal loan for debt consolidation:
- One monthly payment. When you simplify your payment process, you no longer have to manage multiple due dates or risk forgetting to pay a bill. Plus, your payment will be the same each month, so you know exactly how much to budget for this loan payment.
- Improve your credit. When you make on-time regular payments, your credit score will go up. Additionally, if you stop using the credit cards that once carried a balance, your credit usage will decrease, thus increasing your credit score.
- Repay debt sooner. The interest rates on some credit cards and other high-interest loans can be so high that you never pay off your balance. With a debt consolidation loan, you will be able to pay off your debt in a set amount of time.
- Lower monthly payments. When you consolidate your debts, you might be consolidating one that has a year to be paid off, and one that has five years to be paid off. When you consolidate your total balance, it may end up spreading out these payments, thus decreasing the amount you are expected to pay each month.
- Lower interest. If you consolidate your high-interest debt with a personal loan, there is a good chance that you have a lower overall interest rate. This can save you a lot of money throughout the term of your loan.
Debt Consolidation Loans: Cons
Of course, debt consolidation is not for everyone. Here are a few things to watch out for:
- Federal loan forgiveness. If you are consolidating your federal student loans, you may lose many of the advantages that come with federal student loans, including federal loan forgiveness.
- Upfront costs. You may pay an origination fee, a balance transfer fee, closing costs, annual fees and more on a personal loan. Be sure to read the fine print of your loan’s terms before closing on a personal loan to understand the fee structure.
- Profligate spending habits. If you pay off your credit card balance with a personal loan but are in the habit of racking up credit card debt, then a personal loan might just give you more debt. Be sure to use a personal loan to your advantage, not to justify your spending habits.
Alternatives to Debt Consolidation Loans
While getting a debt consolidation loan can help you save money on interest and make repayment a lot more manageable, it’s not always the best solution. Here are a few other options you may want to consider:
Create a Budget
You may want to create a monthly budget that includes making larger debt payments. This can help you decrease the principal on your highest-interest loans, thus decreasing the amount you’ll owe in interest as well.
Debt Management Plan
A debt management plan is a program offered by debt management companies to help you reduce your monthly payments and interest rates on your debt. They may also help you get penalties reduced or waived. If you’ve struggled to make payments in the past, debt management plans can help you get a grasp on your finances while reducing your unsecured debts.
Refinance Higher Interest Loans
If you want to pay off your loan faster, you might be able to refinance your higher interest loans through a balance transfer credit card or other refinancing option. This may require extra fees, but if you can negotiate a lower interest rate or monthly payments, it can be a viable option.
If the bills keep piling up and you feel completely overwhelmed by the amount of debt you have, you may consider filing bankruptcy to get some relief. Bankruptcy is a legal process that relieves debtors from their debts. However, debtors might not be able to qualify for future debts such as mortgages, credit cards, and more. Filing bankruptcy should be an absolute last resort since it will remain on your credit report for seven to 10 years and can impact your ability to qualify for loans in the future.
The Bottom Line
If you have multiple debts and have trouble managing them, then consolidating your debts might be a good way to help you organize your finances. The terms of these types of loans range, normally, from two years to five years. Borrowers with good debt-to-income ratios are more likely to get favorable interest rates. While unsecured debt consolidation loans can be beneficial for some, they do carry risks such as enabling people to maintain profligate spending habits. Be sure to check out balance transfer credit card options.
Tips for Managing Credit Card Debt
- A financial advisor can help you create a budget that aligns with your income and debts. Finding a financial advisor doesn’t have to be difficult. SmartAsset’s free financial advisor tool can quickly match you with up to three local financial advisors who fit your needs. If you’re ready, get started now.
- Beware of debt settlement companies, many of which have gained a reputation as predatory operators. They promise to consolidate debts into one easy payment, but there is often a fee built into the monthly payment. Sometimes they even hold the money to earn interest before making payment to your creditors, resulting in further late fees for you.
For more information regarding statues of limitations by state, please visit this helpful guide from CreditCards.com, State Statutes of Limitation for Credit Card Debt.
For more information on time frames for old debt collection and cash out refinancing, please visit this helpful guide from Bankrate, How long can a debt collector pursue old debt? and Cash-out mortgage refinancing: How it works and when it’s the right option.
Ashley Chorpenning is an experienced financial writer currently serving as an investment and insurance expert at SmartAsset. In addition to being a contributing writer at SmartAsset, she writes for solo entrepreneurs as well as for Fortune 500 companies. Ashley is a finance graduate of the University of Cincinnati. When she isn’t helping people understand their finances, you may find Ashley cage diving with great whites or on safari in South Africa.