Paying off debt can be overwhelming, especially when you have loads of debt from different lenders. Perhaps you have a personal loan with a high-interest rate, along with a student loan you are still paying. Maybe your loan payments are set with an adjustable-rate that rises every month. And on top of all that, you have credit card debt. This is where debt consolidation loans can come into play.
Life can become complicated when just making the minimum payments isn’t keeping your debt under control. If this is the case, you might want to consider reorganizing multiple monthly bills with different interest rates, payments, and due dates. Perhaps consolidating your debt is what will help you gain control over your finances and make your debt payments more manageable.
According to this U.S. News Survey, more than 60 percent of borrowers who have taken out a debt consolidation loan said that it helped improve their credit score. Furthermore, it lowered their monthly payments or even eliminated their debt. On top of all this, you may also be able to receive a lower interest rate on a debt consolidation loan, depending on your credit history.
This guide will help you learn about debt consolidation loans. We’ll cover how they work, its pros and cons, and if combining your debts into one simple monthly payment is right for you.
What Is Debt Consolidation, and How Does it Work?
Debt consolidation is taking out a single loan from a single lender to cover smaller existing debts. It is a way of refinancing debt by receiving funds to pay off what you owe, including high-interest loans, credit cards, medical bills, auto loans, and more. In other words, it combines (consolidates) all your existing monthly bills into the new loan.
You then pay monthly installments to your lender for a set period, rather than making multiple payments each month. The new loan typically comes at a lower, fixed interest rate or with a more relaxed payment schedule. The interest rate usually does not change during the life of the loan.
Debt Consolidation Loans: Combatting Debt
So, how does a debt consolidation loan help you pay down debt? It works on this principle: a lender will loan you the money to pay off your debts by letting you borrow the amount you need. For instance, let’s say you have three credit cards, and you owe $15,000 on them in total. If you qualify for consolidation, the lender will pay off your existing credit card debt with the money and close those accounts. Finally, you make one monthly payment to your lender for the amount you borrowed (in this case, $15,000).
Debt consolidation is one of the ways to pay off debt. The goal is simple: lower the interest rate and your monthly payment, so you can then pay off your debt faster. It will work if you do not have too much debt, or you have learned to control your spending habits. However, before you decide on whether this route is right for you, we want to help you explore your debt consolidation options. That way, you’ll be able to weigh both the benefits and risks first.
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Secured vs. Unsecured Loans
When you borrow money, you will need to decide whether to take a secured loan or an unsecured loan. We’ve outlined the one main difference below.
Secured Debt Consolidation Loan
It’s connected to a piece of collateral, like a house or a car. Then, a lender can take possession of the collateral if you do not pay off the loan according to the repayment terms, which is a significant disadvantage of these loans. The major advantage of secured loans is that they have lower interest rates. Also, qualification requirements are less strict, and they have better repayment terms.
The most popular types of secured loans are car loans and mortgages.
Unsecured Debt Consolidation Loan
This type is not secured by any property that can be repossessed to pay the loan. The lender also cannot automatically take your property, which is a great advantage. However, the disadvantages of unsecured loans are higher interest rates and rigorous credit requirements. Unsecured debt consolidation means that there is no collateral, which makes it a riskier proposition for lenders. As a result, they usually come with higher interest rates.
Moreover, it is harder to qualify for an unsecured loan if borrowers have lower credit scores. Loan amounts also depend on the credit score. If you have good credit (over 780), you might qualify for a $30,000 or $50,000 loan. However, if your credit score is below 650, you are eligible for far less.
The most common types of unsecured debt consolidation loans are credit cards, student loans, and personal loans.
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Which Debts Can or Cannot Be Consolidated?
People who have multiple high-interest credit cards with high balances usually choose to consolidate debt. Research suggests that the average U.S. household with debt carries $15,762 in credit card debt, and more than half of them said that they used a credit debt consolidation.
In addition to credit card debt, debt consolidation programs can include these other types of debt:
- Store cards
- Student loans
- Gas cards
- Medical bills
- Hospital bills
- Cell phone bills
- Utility bills
- Personal loans (not secured by the property)
On the other hand, debt consolidation programs don’t include these types of debt:
- Home equity lines of credit
- Home loans
- Auto loans
- Boat loans
- Legal settlements
- IRS debts
Benefits of Debt Consolidation Loans
A debt consolidation loan is very popular among consumers because it simplifies obligations into a single loan payment. That enables you to save money on interest, pay a lower monthly payment, and even improve your credit. If you can qualify for a debt consolidation loan, you can use it to your advantage.
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Lower Interest Rate
A great benefit of using a debt consolidation loan is that you can save on what you’re paying in interest fees. You can do this if you get a loan with a lower rate than what you’re paying for your credit cards. For example, most people are in debt because they have several credit cards that are maxed out. Credit cards are known to sky-high interest rates. So, if you consolidate two credit card bills into a debt consolidation loan, which usually offers a lower interest rate, you can save money on interest fees.
With debt consolidation loans, you take out a single loan to pay off all of your other debts. You consolidate everything into one single source. This way, you do not have to worry about multiple deadlines, multiple payments, or to figure out which debt to pay first. Instead of managing several separate repayments at various times of the month, you focus your attention on one loan payment. This focus leads us to the next benefit of consolidating your debt.
Lower Monthly Payment
Your monthly payment will be lower since you will have a more extended period to pay off the loan.
Once you consolidate your debt, you will feel less stressed. Why is that? Well, debt is known as a significant source of stress, and if you always worry about making multiple payments each month, stress levels generally will increase. With a debt consolidation loan, you pay a lower payment per month, and that will allow you to focus on the essential things in life.
Debt consolidation loans also help you improve your credit score. If you have bad credit due to making late payments on your monthly bills, you can rebuild your credit and raise your score (if you consolidate your debt into one place and stay on top of the payment).
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Risks of Consolidating Your Debt
Consolidating your debt also has its disadvantages. First, while you will most likely have a lower monthly payment with a debt consolidation loan, you may pay more in interest throughout the years of the loan.
Second, if you take out a secured loan, you are putting your house, car, or another asset at risk. You could lose your assets if you stop paying your credit for any reason.
You Could Increase Your Debt
Third, getting a debt consolidation loan might get you into more debt quickly if you cannot resist temptation and make new charges on your old accounts (before you pay off the loan). Seventy-eight percent of people who received a debt consolidation loan had re-accumulated the debt. That’s a scary statistic!
You Might Still Spend More Than You Make
The main reason why people get debt consolidation loans is that they have been spending more than they earn. So, instead of working on their overspending habits and creating a financial plan to get back on track, they often continue to spend more than they make. As a result, in addition to their loan payment, they end up paying their new credit cards and other bills. This behavior harms their ability to qualify for another debt consolidation loan.
You should close your old credit card accounts and focus only on paying off your consolidated debt. Remember, your goal is to be debt-free, so it is crucial to stay in control of your new loan.
You Could Get Scammed
Finally, another risk that comes hand-in-hand with these loans is running into scam companies. Some of these so-called consolidation companies might leave you with damaged credit by pocketing your monthly payment. Others might urge you to get a high-interest rate loan, which will cost you more in the long run. Therefore, make sure you evaluate debt consolidation services provided by different consolidation companies so that you do not end up with more debt than when you started.
Different Types of Debt Consolidation Loans
There are five different types of loans you can use to consolidate your debt.
Debt Consolidation Loan
Debt consolidation loans are unsecured loans offered by banks and credit unions designed for the sole purpose of combining your debts. These loans usually have a lower interest rate than the rates you are currently paying. You need to have a good credit score to qualify for a low-interest rate.
Home Equity Loans and Home Equity Lines of Credit (HELOC)
These are secured loans that are taken out using the equity in your home as collateral. Since the lender has that security, you are guaranteed to have a low-interest rate on this loan. To qualify for an equity loan, you must have good credit and a fair amount of equity in your home. These consolidation options might be risky because you could end up losing your house if you fail to pay it off.
The difference between home equity loans and HELOC is that a home equity loan is a secondary mortgage that uses the equity in your home as collateral. It provides you with a lump sum and fixed monthly payments. With HELOC, your line of credit depends on how much equity you have and you do not receive a lump sum. Instead, you can withdraw money whenever you need it.
This loan is similar to a home equity loan, but credit requirements for cash-out refinance are lower than they are for home equity loans. If you want to use a cash-out refinance, instead of having two mortgage payments with two lenders, you will have a single payment to one lender. However, keep in mind that if you stop making payments, your home is at risk of foreclosure.
A personal loan is an unsecured loan you can use to consolidate your debt. Unlike a debt consolidation loan, you can use a personal loan on anything you want. For example, if you want to consolidate debt that is worth $15,000, you can borrow $20,000 and use the other $5,000 on something else. However, you might not be approved for a personal loan if you have bad credit. Even if you are, it will be at a higher interest rate.
With a balance transfer, you transfer your credit card debt onto a single credit card. The new creditor of the balance transfer card pays off your credit card bills to complete the credit debt consolidation. If you decide to go this route, look for a low (2.99 percent) or zero percent APR introductory interest rate for a balance transfer for at least the first six months (up to 24 months). You can make larger payments on that card until it is paid off, hopefully before the rate increases. However, if you choose this debt consolidation option, make sure you do not miss payments. Doing so can trigger a loss of your low or zero percent introductory APR.
Alternatives to Debt Consolidation Loans
Debt consolidation loans are a consideration for people with debt. However, debt consolidation may not be sufficient if, for example, your debt exceeds your income or you have bad credit. In such cases, you should investigate alternatives. These can include debt relief, a debt settlement, payday loans, or bankruptcy.
If you need help concerning your debts and your financial situation, you can ask credit counselors for advice. Additionally, you can consider debt management and debt settlement. Debt relief services are helpful because they can help you choose the best strategy for paying off your debt (plan repayment). They can also help you settle accounts for less than the full balance.
Funded by banks and other financial institutions, credit counseling organizations provide free or low-cost financial education services. These include a debt management plan, an agreement between borrowers and creditors created to lower interest rates, avoiding penalty fees, and consolidating balances into a single monthly repayment. These services also include developing a budget, money management, and other workshops and educational materials designed to assist you in improving your entire financial situation.
When searching for a credit counseling organization, look for qualified, accredited counselors that have licensing in your state and offer comprehensive services. They should also offer assurance that they will keep your personal and financial information confidential.
Credit counseling organizations offer debt management. These organizations create a plan for managing debt and negotiate with your creditors to reduce interest rates or forgive late fees. That will give you a more manageable way to pay down your debt. Credit counselors take payments from you and use them to pay off your debt as agreed. The creditor pays a percentage to credit counselors for every payment you make. Be aware that credit counselors may charge expensive fees.
A debt management plan (DMP) is suitable if you have credit card debt, a personal loan, a payday loan, or overdrafts.
A for-profit organization that negotiates balance reductions with your creditors offers these programs. However, even though this process can dramatically improve your credit (up to 100 points for borrowers who previously had good credit), you need to be careful when considering this debt consolidation alternative.
First, debt settlement companies often charge expensive fees, usually anywhere from $7,500 to $10,000. For example, if you have $50,000 in debt, your debt increases after the additional fees, so you will now owe $57,500 to $60,000.
Second, to get creditors to negotiate with them, they might encourage you to make bad decisions, such as stop paying your credit card bills. If you do that, you will end up with late fees, penalty interest, and other charges.
Lastly, working with settlement companies can hurt your credit score, as settled accounts leave a negative effect. That is, they stay on your credit report for seven years.
You can file for bankruptcy if you have serious debt you are unable to pay, or if creditors are suing you. When you register for bankruptcy, you can make a plan to pay off debts, or your debts could be wiped away, depending on the type of bankruptcy you choose. However, declaring bankruptcy is a last resort because it comes with these consequences:
- Bankruptcy remains on your credit report for up to 10 years.
- You cannot get a mortgage after declaring bankruptcy.
- It does not relieve student debt.
- You lose all of your credit cards.
Also, you can say goodbye to any luxury possessions you may have.
There are two main types of consumer bankruptcy: reorganization and liquidation. With the restructuring, you will have a new plan for paying your unsecured debts. With a settlement, many of your unsecured debts get discharged, but you might have to sell assets to make a repayment to your creditors.
A payday loan, also called a cash advance loan, is a type of short-term loan where a lender will extend credit, depending on your income and credit profile. These loans have high fees and interest rates, far higher than your existing credit card debt, with a $15-per-$100 fee that equates to an APR of almost 400 percent (it is 459 percent in California).
Borrowing From Yourself
Instead of borrowing from a bank or other financial institution, some people opt for another alternative: they borrow from themselves. For instance, you can borrow from your 401k savings account. This idea isn’t the best, but it can work in case of a financial emergency.
According to the law, the maximum amount you can borrow is $50,000 or 50 percent of your vested account balance. You pay interest to yourself. There are also usually tax penalties associated with borrowing from your 401k before retirement age.
Additionally, you can borrow from your cash value life insurance policy. But before you do, find out if a loan will affect your death benefit.
And finally, instead of using a debt consolidation loan to pay off debt, you can use a home equity line of credit.
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Typical Requirements for Debt Consolidation Loans
Before applying for a debt consolidation loan, you first need to evaluate the requirements to ensure not only that it is the best choice for you. You also need to determine the likelihood of being approved. Typically, you have to be 18 years old and a legal U.S. resident with a valid bank account to qualify for a debt consolidation loan. But, lenders will look into other information before they approve you a loan.
Some lenders are prone to accept credit scores as low as 580, but others require a higher credit score. Borrowers who have an excellent credit score and low debt-to-income ratios may qualify for lower interest rates. Borrowers with bad credit may be able to get an unsecured personal loan, but the interest rates might go up to 36 percent.
A debt-to-income ratio is an amount you get after adding up your debt payments throughout the month and dividing that number by your gross monthly income. Lenders use this ratio to determine whether you can make a loan payment each month. You might get approved even if you have a ratio as high as 50 percent.
Some lenders require employment details to determine whether you have the income needed to make loan payments. They might ask for a pay stub as proof of your income. Additionally, they may ask how long you have worked for your current employer.
Lenders often look at your assets before letting you borrow vast sums of money. So, to qualify for a debt consolidation loan, you need to have a respectable amount of home equity. For example, for $60,000 in home equity, you can consolidate up to $50,000 of debt.
Lenders also check your credit history, your overall stability, living history, etc. Some require that borrowers have no current delinquencies, tax liens, bankruptcies, or foreclosures.
Institutions That Offer Debt Consolidation Loans
There are different types of financial institutions that provide debt consolidation loans:
- Credit unions
- Specialized lenders
- Peer-to-peer lending services
If you have good credit, you can get a secured or unsecured debt consolidation loan at national and community banks. Rates and borrowing limits vary widely, and they depend on your credit profile and other requirements. With banks, you’ll need to pay the full repayment within 60 months (five years).
Credit unions are also debt consolidation loan providers. Unlike with banks, you’ll need to pay back the full repayment within 12 to 60 months. Borrowing limits vary widely, just like with the banks. If you are a borrower with below-average credit risk, you can get a loan with a flat 6.99 percent APR.
Specialized lenders, also known as finance companies, offer debt consolidation loans. Unlike banks and credit unions, these lenders do not accept deposits. They pay a debt to your creditors and send you monthly bills. Their credit history requirements are also less strict in comparison to banks, but the rates can be higher for borrowers with mediocre credit.
Peer-to-peer lending enables individuals to get loans directly from other individuals, taking a cut of the interest charged. These websites connect borrowers directly to investors. Rates can range between 6 and 8 percent APR for borrowers with excellent credit, to more than 30 percent APR for those with bad credit.
How to Choose the Right Debt Consolidation Loans
Debt consolidation loans can be a useful solution if you have a great deal of debt. When choosing the right debt consolidation loan for you, there are several things you will want to take into consideration:
Look For a Reputable Company
Some institutions such as banks, credit unions, and some lenders offer debt consolidation loans. When choosing the right company, research several different lenders, get references, and make sure a third party accredits it. Be extra careful if you have bad credit because many scams might even require an upfront deposit.
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Compare Interest Rates
Get multiple quotes from different lenders and compare interest rates. Since the interest rate on a debt consolidation loan is usually higher than the loans you currently have, you might need more time to shop around. This research will help you find the lowest rate that best meets your financial needs. Your goal is to secure the best deal. Therefore, choose a debt consolidation loan that is going to save money on your monthly payment and total amount. This choice shouldn’t be too hard since the competition in the marketplace is fierce.
Beware of Fees
Do your homework and find out if there are fees associated with your loan. Check if there is a prepayment penalty and always read the fine print.
A Few More Things to Consider Before You Opt for Debt Consolidation Loans
Now that you have learned valuable information about debt consolidation loans, there are other things you need to be aware of before you contact your bank or a specialized lender to apply for a loan. Consider the following truths:
- Debt consolidation is not debt elimination! Debt consolidation enables you to reconstruct your debt, which means that your debt is not forgiven or reduced. Instead of multiple bills, you pay a single loan.
- You will have to pay for a more extended period after consolidating debt. Debt consolidation will not help you get out of debt faster. Because to have lower payments, you will need to prolong your loan, which means you will need more time to pay it off.
- You also need to change your spending habits. Many people who consolidate debt and do not change their lifestyle end up with growing debt. Consolidation is not the key unless you change spending habits and establish good money behavior.
- Lower interest rates might not stay low. There is no guarantee that your interest rate will remain low. Some consolidation companies inflate the interest rate over time, leaving you with more debt. Look for loans with fixed rates to prevent any unpleasant surprises down the road.
The Best Debt Consolidation Loans of 2019
Marcus by Goldman Sachs
Marcus is among the best lenders for several reasons.
First, it promises no fees. There is no origination, prepayment, or late fees.
Second, it offers competitive interest rates, ranging from 5.99 percent to 28.99 percent APR (5.99 percent to 24.99 percent for New York residents). Marcus’s maximum APR is also lower than other lenders (around 36 percent).
Third, customers appreciate Marcus’s simple pre-approval process that only requires general background info, including income, credit score, and monthly housing costs. Its extremely courteous customer service is the icing on the cake.
If you want to get a new loan on FICO 9, then you need to provide a minimum credit score of 660. On the contrary, the VantageScore 3.0 scale requires a score of at least 580, and loan amounts range from $3,500 to $40,000.
SoFi is another lender that has started with student loans. Today, this non-traditional lender’s services include personal loans for debt consolidation. SoFi is excellent because it does not charge any of the fees that are standard with debt consolidation lenders, just like Marcus. There is no origination fee, no late payment fee, and no charge if a payment fails to go through.
SoFi stands out for offering a max fixed APR of 14.87 percent and loans from $5,000 to $100,000. It requires a minimum 680 credit score.
SoFi has overwhelmingly positive feedback on its mobile app, with an outstanding 4.9 stars (out of 5) in Apple’s App Store.
Lending Club is the largest loan marketplace of its kind, with $38 billion in loans funded. To qualify for loans that range from $1,000 to $40,000, you need to have a 600 or higher credit score and a debt-to-income (DTI) ratio of about 12 percent. The maximum debt-to-income ratio is 30 percent.
Lending Club has one of the lowest minimum APRs, at only 6.16 percent. It remains trendy among customers, despite some controversy in 2016. Lending Club’s former CEO was involved in padding reported loan volume and splitting loans to make them appear less risky to investors.
Perhaps the only downside of this lender is that it charges a higher check processing fee than other lenders.
If your credit record is in poor condition, then OneMain Financial is ideal for you. It has no minimum credit score and offers interest rates from 16.05 percent to 35.99 percent. If you cannot get approved elsewhere due to your bad credit, OneMain Financial may be your only option. However, you will have to bite the bullet on higher interest rates.
OneMain Financial offers loans ranging from $1,500 to $30,000 across its physical branches in 44 states. Loan terms vary from two to five years. Borrowers can get funded the same day.
If you’re aiming for a lower interest rate, you can obtain a secured loan with OneMain Financial. However, you could lose collateral if you stop making payments.
Discover Personal Loans
Discover Personal Loans is perfect for borrowers with good credit. It offers loans of $2,500 to $35,000 with three- to seven-year terms. To qualify, you need to have a 660 credit score and above. Interest rates are competitive (from 6.99 percent to 24.99 percent APR), depending on your credit.
There are no origination fees.
The only downside of Discover Personal Loans is that it takes up to seven days to get funded.
Prosper launched in 2005. This lender is ideal for borrowers with a debt-to-income ratio of up to 50 percent. It has an easy pre-approval process that only requires your name, address, credit score, and income, without requiring taxable income information.
Prosper offers loan amounts ranging from $2,000 to $40,000, with three- to five-year terms. The company’s minimum credit score is 640.
Origination fees are up to 5 percent.
On the downside, Prosper is a little less flexible than other lenders because once it sets the due date for your monthly bills, it remains unchanged.
The Payoff is an excellent choice for a debt-free plan because it is designed specifically for paying off credit card debt. Payoff’s services stand out among the competition because Payoff offers customers support in putting together a personal debt payoff plan. That keeps you focused on reaching your debt reduction goals.
To qualify for a loan from Payoff that ranges from $5,000 to $35,000, you will need a credit score of at least 640 and a debt-to-income ratio of 50 percent or less.
Interest rates are ranging from 5.99 to 24.99 percent APR. You can expect your funds anywhere from two to five days with Payoff.
Upstart is an online marketplace lender that approves loans to borrowers who have bad credit or no credit history.
Upstart requires a minimum of 620 as a credit score and offers loans from $1,000 to $50,000, with a loan term from three to five years.
Borrowers can expect to receive the funds within two business days.
However, Upstart charges an origination fee of up to 8 percent on some loans, which is a significant drawback. It also charges late fees of $15 or 5 percent of the amount past-due, whichever is greater.
Best Egg is famous for offering some of the best interest rates — ranging from 5.99 to 29.99 percent, based on your credit history.
Best Egg offers three- or five-year loans that range from $2,000 to $35,000. You are eligible for a loan if your credit score is 640 or higher.
The origination fee is from 0.99 percent to 5.99 percent.
Borrowers can get funded the same day they apply.
We Want to Hear From You!
Have you ever had a consolidation loan? What are your tips for readers wondering whether to get one or not? Please feel free to share in the section below.