Are Debt Consolidation Loans a Good Idea?

A debt consolidation loan is a type of personal loan. Consumers apply for one, intending to use the lump sum they get to pay off several debts at once. This rolls the balance into a single loan. This strategy helps consumers streamline their finances and reduce multiple payments into one.

Here’s more information about how debt consolidation loans work and the pros and cons of applying for one.

How do debt consolidation loans work?

If you’re interested in getting a debt consolidation loan, here’s a glimpse of the process.

Research lenders

First, it’s important to research the best debt consolidation loans. Make sure they’re reputable and have a history of providing excellent service. Lending scams are common; scammers prey on people who want debt relief. If you’re unfamiliar with a lender, see whether it has a Better Business Bureau profile.

Once you’ve narrowed your search to two to three reputable lenders, choose the one that offers the best terms for your personal situation. The most important terms to consider are the loan APR, the length of your loan, your monthly payment, and how soon you will receive funds.

Usually, the shorter the loan period you select, the better the interest rate you’ll get. However, if you want to reduce your monthly obligations, you can also choose a long repayment term to get the lowest monthly payment possible.

Fill out an application

On your application, you’ll need to provide personal information, such as your Social Security number, address, and income. You’ll also write down how much money you want to borrow. 

Having all your documents ready before you apply can help the application process go smoother and faster. 

Get approved and deposit your lump sum

Once you submit your application, it might take time to hear back because the lender will review and verify your documents. However, once you’re approved, your lender can directly deposit your funds or send you a check. Depending on the lender, this can take several days to a few weeks.

Pay off your debt and avoid new debt

Once you get your lump-sum payment from your debt consolidation loan, use that money just as you intended. Pay off your other debts with the money you receive. This strategy should help you to pay off high-interest debt and move your balances to a single loan with a lower interest rate.

Once you’ve moved your debt, work hard to develop positive money habits and avoid going back into debt on your credit cards. You can even freeze your credit after getting your loan to help you stay disciplined and avoid using your card. When possible, pay extra on your debt consolidation loan to get out of debt faster.

Our expert’s advice

Erin Kinkade

CFP®

Don’t close out your credit card account. This can have a negative impact on your credit score and report by increasing your credit utilization rate. This seems counterintuitive, but as we mentioned above, freezing your credit card account after paying it off is a smart recommendation.

A debt consolidation loan can be a terrific tool for accelerating debt payments and streamlining monthly payments. But try not to rush the process. It’s important to research lenders and choose the one that’s best to help you move forward with your finances.

Pros and cons of debt consolidation loans

Here are several pros and cons of a debt consolidation loan. Moving your debt to a personal loan has many perks, but consider the drawbacks too.

Pros

• Streamline monthly payments

• Lower interest rates

• Fixed terms 

• Improved credit score

Cons

• Higher long-term costs

• Origination fees

• Not guaranteed to change habits

• Temporary score drop

Pros 

Here’s more about the benefits of a debt consolidation loan.

Streamline monthly payments

According to the Consumer Financial Protection Bureau, consumers incur over $14 billion in credit card late fees each year. The more bills you have to manage, the more likely you’ll accidentally miss a payment. Streamlining your bills into a single monthly payment can go a long way toward helping you organize your finances and ensure you make payments on time.

Lower interest rates

The most recent Federal Reserve data shows the average personal loan interest rate is 12.35%, whereas the average credit card interest rate is 21.47%. By consolidating credit card debt into a personal loan, consumers can save on interest costs over time.

Fixed terms 

Debt consolidation loans come with a set repayment term, which can be up to 10 years or more. This term allows borrowers to make the same monthly payments and have a specific payoff date. Streamlining and organizing your finances with predictable monthly payments helps you better plan your financial future. 

Improved credit score

A 2019 TransUnion study showed that 68% of consumers who used a debt consolidation loan saw a 20-plus point increase in their credit scores. If you use a debt consolidation loan to pay off high-interest credit card debt, your credit score will likely increase because you’ll improve your debt-to-credit ratio. This ratio, also known as “amounts owed,” makes up 30% of your score.

Cons

Consider the following before getting a debt consolidation loan.

Higher long-term costs

When you consolidate your loans, you sign up for a new loan and new terms. This means you might repay your debt for a longer period, paying more interest overall. It’s wise to run the numbers to learn how much it would cost to pay off your debt quickly versus consolidating it into a new loan.

Origination fees

Some lenders charge origination fees, which can be up to 10% of your loan. When comparing lenders, it’s smart to find out whether they charge origination fees and how much they are. 

Sometimes, a lender might seem like a better deal because it offers a low interest rate, but then you realize it has high origination fees. So, when evaluating lenders, ask questions about their fees and costs so you can compare them equally.

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Tip

The annual percentage rate (APR) on your loan considers the simple interest rate plus fees, such as origination fees. Comparing APRs can give you an apples-to-apples comparison of your loan offers.

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Not guaranteed to change habits

Consolidating debt can help reduce monthly payments and streamline your finances, but it doesn’t always change the root cause of debt accumulation. It’s important to take the time to self-reflect and understand why you got into debt in the first place. That way, consolidating your debt can be the first step to your new, financially organized life.

Temporary score drop

Whenever you apply for a debt consolidation loan, a lender will make a hard inquiry on your credit. This causes a temporary score drop of a few points. However, the effects of this drop will wear off over time. If you can pay off high-interest debt with the loan, your score will likely go up once you free up more credit.

Is debt consolidation a good idea for you?

A debt consolidation loan might not be right for every situation. Here are several financial scenarios you might be experiencing and our opinion on whether you should consider a debt consolidation loan as a next step.

Financial scenario	Are debt consolidation loans a good idea?
Good credit with high-interest credit card debt	✅ Consider it
Current debt payments are manageable with low interest rates	❌ Reconsider it
Struggle with overspending and shopping	❌ Reconsider it
Want to lower interest rates on current debts	✅ Consider it
Unable to qualify for a consolidation loan with a lower interest rate than current debts	❌ Reconsider it
Willing to develop positive money habits and make a financial management plan	✅ Consider it
Struggling to manage multiple debt payments each month	✅ Consider it

If you’re still unsure whether a debt consolidation loan is right for you, ask yourself whether you would feel relieved by consolidating your debts. For some people, it’s worth applying to alleviate significant financial stress. Others who want to pay off their debt quickly and don’t want to go through the process of applying for another loan might not need to consolidate.

Our expert recommends other strategies

Erin Kinkade

CFP®

Consider establishing your own repayment plan without consolidation. A common strategy is the debt snowball, where you repay the smaller loan first. This is intended to build confidence and efficacy. You then apply the amount you paid on the smaller loan to the next debt owed, and so on. Another common strategy is to pay off the high-interest-rate loan first. I recommend engaging with a counselor, such as an Accredited Financial Counselor (AFC). They can offer low-cost help or volunteer at no cost. Another option is to ask a trusted family member or close friend, but these are rare opportunities and can be tricky to navigate so as not to damage the relationship. Another option could be a GoFundMe. Tell your story about why you are in debt. I would not suggest this for somebody who has been through a crisis or other major life event they experienced that caused financial hardship.

How to get a debt consolidation loan

If you’re ready to apply for a debt consolidation loan, you can find a lender by contacting banks, credit unions, and online lenders. Several comparison websites, such as Credible, make it easy to view the terms of various loans in one place. If you have a good relationship with your local bank or credit union, that’s an excellent place to start.

You should only apply for a debt consolidation loan if you have a steady income, proof of that income, a good credit score, and a lower debt-to-income ratio. Lenders have different requirements, but most will consider your employment and credit history when determining your eligibility for a debt consolidation loan.

You may need to provide the previous year or two of tax returns, business profit-and-loss statements if you’re self-employed, pay stubs, and your license or other forms of identification.

Expect the full process of researching lenders, applying for debt consolidation loans, and paying off your higher-interest debt to take a few weeks. If you need money soon, ask lenders how long the process takes ahead of time so you can narrow your search to quick loans and lenders.

FAQ

Do debt consolidation loans hurt your credit?

Debt consolidation loans may affect your credit. You may see an initial slight dip in your score as a result of the hard inquiry from the lender to assess your creditworthiness. Closing old accounts once your debts are consolidated might also lower your score. However, these are often short-term declines and should recover with disciplined repayment.

Is it hard to get a debt consolidation loan?

It often depends on your financial circumstances. High credit scores and low debt-to-income ratios tend to encourage lenders to approve your application. If your credit score is mediocre or you carry high debt relative to your income, it might be more challenging.

How long does it take your credit to recover from debt consolidation?

Recovering your credit score after taking out a debt consolidation loan is no overnight task. It might take anywhere from a few months to a year or more, depending on your individual circumstances. Factors including your repayment history, credit utilization rate, and the length of your credit history all contribute to the recovery time.

How much debt is too much to consolidate?

The threshold varies based on the lender and the borrower’s financial health. Some lenders might enable you to consolidate up to $50,000, and others may allow as much as $100,000. As the borrower, you must be confident in your ability to make the necessary repayments within the loan’s terms.