Debt Consolidation Loans

Debt consolidation loans combine two or more debts into one, easy-to-manage monthly payment, though there are ways to consolidate debt without a loan.

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What Is a Debt Consolidation Loan?

A debt consolidation loan is a financial strategy to pay off multiple high-interest debts with one, low-interest loan. It simplifies bill paying – and saves money – for consumers dealing with numerous unsecured debts like credit cards, medical bills or personal loans.

Debt consolidation loans allow borrowers to merge two or more debts into one loan at a lower interest rate.

Debt consolidation loans work simply: You borrow what you need to pay off credit card debts, then make a single monthly payment to the lender.

The advantages are that debt consolidation loans usually carry a lower interest rate – which means less money paid — and there is only one check and payment due date each month.

Consolidation loans usually have terms of 2-to-5 years, depending on the amount borrowed.

How to Get a Debt Consolidation Loan

You can find a loan for debt consolidation at the familiar places – banks, credit unions, online lenders – but do some research and comparison shop before choosing this option.

It is important to understand that debt consolidation loans do not eliminate debt. They restructure the debt, ideally in a more favorable way, but you still end up paying back what you owe. Before looking for a debt consolidation loan, do some homework that should make the process easier and the chances for success much higher.

Before consolidating debt:
  • Identify the bills you want to consolidate: Secured debts – like mortgages, auto or boat loans – don’t qualify for consolidation. Debt consolidation loans deal almost exclusively with credit card debt.
  • Examine your budget: How much of a monthly payment can you comfortably afford after taking care of the necessities?
  • Order your credit report: It’s free and it will note all your debts, including some you may have forgotten.
  • Check your credit score: It’s also available free via numerous online sources. It will be a factor in some of the loan options, so know where you stand and be realistic about what to expect.

When to Use a Debt Consolidation Loan

The best time to consider a debt consolidation loan is when you want to pay off debt from multiple credit cards by reducing the interest rate.

Basic questions need to be answered before going ahead with this kind of loan. If your debt is less than 50% of income, consolidation may be a good option. If it’s more than 50% of your income, debt settlement or bankruptcy could be better options.

Among the questions to consider about consolidation:
  • Will I lower my payment? If the answer is yes, proceed. If you’re not lowering your payment, this makes no sense. .
  • Will I lower my interest rate? With interest rates overall at historic lows, finding a better rate should not be that challenging.
  • Will this help my credit? If your credit cards are maxed out, you’re using a ton of available credit. By taking out a debt consolidation loan and paying off the charges, you’ll lower your utilization rate, which can improve your credit score. Just be sure to make on-time payments once you consolidate.

If the answer to any one of the above three questions is yes, it’s worth looking into consolidating. You’ll have to qualify, but imagine the relief if this loan gets you out of debt. However, you also must examine your budget and spending, or this same problem can persist. . .

Secured vs. Unsecured Debt Consolidation Loans

Debt consolidation loans are just another name for personal loans and there are two types available – secured and unsecured – with many variations under each category.

A secured debt consolidation loan – just like a secured personal loan – is backed by collateral such as home, car or property and is the easiest route to consolidation.

Unsecured loans are those backed only by the borrower’s promise to repay. If you want to go the unsecured loan route, add online lenders to the list of possibilities.

Secured Loan: Positives and Negatives

+ Easier to obtain

+ Higher borrowing amount allotted

+ Lower interest rate

+ Interest may be tax deductible

Longer repayment terms (higher cost in interest over time)

Risk of losing collateral such as house or car if you default

Unsecured Loan: Positives and Negatives

+ No asset risk

+ Shorter repayment term (lower cost in interest over time)

Harder to obtain from a lender

Lower borrowing amount allotted

Higher interest rate

No tax benefits

Types of Debt Consolidation Loans

There are four major types of debt consolidation loans: Home equity loans, credit card balance transfers, loans from family or friends, and unsecured personal/debt consolidation loans.

Here is a look at the pros and cons of each type of loan.

Home Equity Loans

If you have equity in your home, using a home equity loan for debt consolidation could be the best choice for eliminating credit card debt.

The interest rates on a home equity loan should be substantially less than what you pay the credit card companies. In November of 2020, the interest rate on home equity loans was around 5.5% (even less in some places) while the average interest rate on credit cards was 17.98%.

If you owed $15,000 on credit cards and tried to pay them off with a home equity loan in five years at 5.5%, your monthly payment would be $286.52 and you would have paid a total of $2,191 in interest.

The same $15,000 debt paid off over five years at the average credit card interest rate of 17.98% would mean monthly payments of $376.83 and total interest paid of $7,854.

That’s $5,663 in savings over five years!

Of course, the amount of equity you have in your home (home’s current value minus what is owed) determines how much you can borrow, but it should be enough to cover the credit card bills.

Credit Card Balance Transfers

The least expensive choice for a debt consolidation loan is a 0% interest balance transfer card. These cards allow you to transfer the balance from all your credit cards to a single card and pay that off with no interest for an introductory period ranging from 6-to-24 months.

If you’re smart and responsible, this is one time when you have the edge over the credit card companies.

There are three major concerns about balance transfer cards as debt consolidation loans:
  • Will you qualify for one?
  • How much are the transfer fees?
  • Will you be able to pay off the debt before the 0% offer expires?

Qualifying requires an excellent credit score (740 or higher) for the best deals (18-to-24 months at 0% interest) and at least a 680 or higher score to qualify for any of the rest (6-to-18 months at 0% interest).

Any score under 680 and it’s unlikely you will get a 0% interest rate. If you do, the introductory period will be six months.

Pay close attention to balance transfer fees, which some credit card companies charge up front. Most cards charge 2-to-3% of the amount owed. If you owe $10,000, that means another $200-to-$300 added to your bill.

Which brings us to the big question: Can you pay off your entire debt in the time frame allowed? If you don’t, the regular interest rate kicks in on the balance, and the range in late 2020 was somewhere between 16% and 25%.

Once again, do ALL the math, before deciding this is the right way to eliminate credit card debt.

And if you are unsure you can pay off the loan before the term expires, look for another option.

Loan from Family or Friends

If Mom, Dad, a close brother or Aunt Betty has some savings and are amenable, this could be the best option. Family members tend to not be so onerous about borrowing. Terms and interest rates are flexible and could easily be changed to accommodate a change in your financial situation.

Be aware, though: This option is loaded with potholes that could make the next holiday or birthday most uncomfortable. If the situation becomes difficult among family and/or friends, you may wonder why you ever did it.

The plus side of getting a consolidation loan from a family member or friend is that they are not competing with another lender so they can set the interest rate however low (or high) they want. The loan could even be at 0% interest.

The same goes for the terms. The loan can be for any length of time and shortened or extended whenever necessary. Family members can be much more flexible than banks.

Whatever the terms, it should be a win/win agreement that serves both sides. It should spell out the obligations in simple terms and, most importantly, it should be written down in case things get dicey.

Paying off credit cards at a cheap rate is not worth losing a long-term relationship. If you choose this path, tread carefully.

If you do choose this option, be kind to the relative who loans you the money once you repay the debt. A thank you in the form of a gift card or selection of fine cheeses seems appropriate.

Personal Loans for Debt Consolidation

Personal and debt consolidation loans are different names for the same thing: an unsecured loan that comes with an interest rate based on credit score.

It can be a worthwhile solution for consumers with heavy debt that is spread out over several credit cards. Essentially, this loan allows you to pay credit card debts in full. A new, large loan replaces several smaller ones.

Taking out a consolidation loan is beneficial in the following ways:

However, if you have a low credit score or dings in your credit report, you may not be approved for a consolidation loan. Rates for consolidation loans in November of 2020 ranged from 6% to as high as 36%, so even if you are approved, your rate may be so high that it doesn’t make sense when compared to what you currently pay.

Will Debt Consolidation Loan Affect My Credit Score?

A debt consolidation loan can offer an opportunity to improve your credit score, but you must make timely payments. Use the loan as a part of your financial planning, not as a way to simply shift debt.

When you take out the loan, your lender will pay all your credit card debts. That reduces your credit utilization ratio, which improves your credit score. Paying the new loan regularly and on time – this is important! — also helps.

However, this option also can hurt your credit score.

Opening a new credit account reduces the average age of all your accounts. This figure is part of determining your length of credit history. The longer you’ve shown you are reliable, the better your credit score.

Merely applying for a consolidation loan leads to a hard credit inquiry, which will lower yours core by a few points. A hard inquiry is merely the check a financial institution does when you apply to borrow money.

If you don’t have a strong credit rating, contact a credit counseling agency to review other options. They may recommend a debt management program that will help you set up a budget and pay off the debt within 3-to-5 years.

Be aware: Not every financial problem can be solved through a debt consolidation program. There are some situations where debt settlement or even bankruptcy are the best solution to the problem.

Helpful Tips to Remember When Entering into a Debt Consolidation Loan Agreement
  1. Do your research: Different banks offer competitive loan rates and varying repayment terms. Keep your options open. Credit unions, most of which have easy membership qualifications, can contend with the bank’s competitive rates as well.
  2. Stick to a budget: Before you settle on your consolidation loan’s monthly installments, measure your income against your expenses to determine a realistic monthly payment.
  3. Make the loan a priority: Pay off the consolidation loan before taking on new financial responsibilities. Don’t inquire about your eligibility for new credit card promotions or run up any additional debt on your existing cards, as both of these will have a negative effect on your credit score.

Alternatives to Debt Consolidation

A debt consolidation loan is not for everyone. Alternatives are available.

Credit counseling is available for those unsure which way to turn. A counselor can go over your financial situation, and present options. Sometimes talking things through makes the situation clearer.

Debt management is a program run by nonprofit credit counseling agencies to help consumers eliminate credit card debt in a 3-to-5 year period. The counseling agencies go over your budget to determine a monthly payment you can afford. They then work with credit card companies to reduce the interest on card debt so you can safely make that payment every month.

Credit scores are not a factor in debt management programs. This is NOT a loan, but rather a monthly payment program that helps you get out of debt.

About The Author

Bill Fay

Bill “No Pay” Fay has lived a meager financial existence his entire life. He started writing/bragging about it seven years ago, helping birth into existence as the site’s original “Frugal Man.” Prior to that, he spent more than 30 years covering college and professional sports, which are the fantasy worlds of finance. His work has been published by the Associated Press, New York Times, Washington Post, Chicago Tribune, Sports Illustrated and Sporting News, among others. His interest in sports has waned some, but his interest in never reaching for his wallet is as passionate as ever. Bill can be reached at


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