How to Consolidate Personal Loans: Steps and Tips
Updated: July 25, 2023
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Debt consolidation combines multiple debts into one single loan. You can consolidate debts like student loans, credit cards and personal loans. Consolidation grants an opportunity to get a lower interest rate, a longer repayment term and the chance to eliminate debt faster.
While this may sound tempting, there are a few important factors you should consider before consolidating debts. A thorough understanding of how and when to consolidate loans will help you find the right option for your needs.
What Is Debt Consolidation and How Does it Work?
Debt consolidation involves taking out a new, large loan to pay off multiple debts. You might want to consolidate personal debts for several reasons, such as getting a better interest rate, reducing monthly payments, paying only one payment a month or even improving your credit score.
Banks, credit unions and online lenders offer debt consolidation options in the form of personal loans, home equity lines of credit (HELOC) or credit card balance transfers. However, depending on the lender, the new loan may come with stringent requirements. Lenders look at factors like your credit history and financial status to determine if you can repay a consolidation loan.
If you qualify, know that consolidating your debt may also come with certain fees, depending on the lender. For instance, a balance transfer credit card may come with a balance transfer fee to move your debt from one card to another. Other typical fees for consolidation loans include origination, application, late payment and early payment fees.
Pros and Cons of Consolidating Personal Loans
Consolidating debt comes with advantages and disadvantages; it’s important to weigh the pros and cons to make the right decision for you.
Ways to Consolidate Personal Loans
There is more than one way to consolidate debt. For instance, you can use a credit card balance transfer, tap into home equity or get a new personal loan to consolidate debt.
Transferring a credit card balance involves taking out a new card and getting approval from the lender to move the balance. You can do this with several cards at the same time.
If you have a home and have built equity, there are three ways you can utilize that to consolidate other debts you may have. You can do so through a home equity loan, a home equity line of credit (HELOC) or a cash-out refinance.
A personal debt consolidation loan is simply a personal loan. Personal loans are generally unsecured, and your loan amount, creditworthiness and income all play a role in determining your annual percentage rate (APR).
How to Consolidate Personal Loans
If you think that consolidating personal loans is the right step for you, there are a few steps you can take to get started.
Collect and organize your debts
List the debts you want to consolidate, including your current balances, interest rates and terms for each one. This gives you a good idea of how much you need to borrow and what an ideal interest rate is.
Choose a debt consolidation option
Decide how you want to consolidate your loan, whether through a balance transfer, a personal loan or by tapping into your home’s equity.
Compare loan offers
Gather quotes from several lenders and find an ideal option for you. Try to strike a balance between a low interest rate and a manageable repayment term.
Complete and submit the application
When you’ve decided on a lender, complete and submit the application for your loan. This can typically be done online, but some loans may require a phone call or in-person visit.
Create a budget and repay the loan
If your application is approved, add the monthly repayment to your budget. Once you get the funds, start repaying the loan according to the terms.
Is Debt Consolidation Right for You?
While debt consolidation can be beneficial, it may not suit everyone. Understanding when it is and isn’t a good idea can help you make the right decision and avoid unnecessary debt.
When Consolidating Is a Good Idea
- If your credit score has since improved: If your credit has improved since you last took out your loans, you may qualify for better rates or terms.
- If you need to cut down on the number of loans you’re managing: If the number of payments you need to make monthly becomes difficult to manage, consolidating your debt may make repayments easier.
- If you want better terms: If the interest rates on your debts combined are too high or your repayment terms are unfavorable, consolidating your debts may help.
- If you want a lower monthly payment: Combining multiple debts into one may help you get a lower monthly payment — which can help if you’re struggling to repay the minimum on multiple loans.
- If you have several high-interest loans: If all your loans have high interest, it might be beneficial to consolidate them and have only one loan and interest rate to manage.
When Consolidating Is a Bad Idea
- If your credit score has not improved: A low credit score could make a consolidation loan offer come with higher rates or worse terms, which could lead to paying more interest in the long run.
- If you cannot pay for your new loan: If the terms and interest rate you get lead to a monthly payment you can’t afford, then consolidating may not be a good idea.
- If the interest rate offered is high: A high interest rate can make debt consolidation counterintuitive, as it may lead to higher monthly payments and more interest paid over time.
FAQs About Consolidating Personal Loans
We have answered some questions below that you may have about consolidating personal loans.
No. Debt consolidation involves taking out a new loan to pay off multiple debts, while debt settlement involves a third party negotiating with your lender to reduce your debt to an agreed-upon amount.
As consolidating your debt involves opening a new line of credit, it may temporarily decrease your credit score. However, consistent payments will ensure that your credit bounces back over time.
A personal loan and a consolidation loan are essentially the same things. Lenders do not distinguish between the two, as personal loans can be used for various reasons, including consolidation.
A consolidation loan will stay on your credit records while you repay it, and may show up for several years after you have paid it off. Settling debt can stay on your credit report for seven years, according to Experian.
It depends on your financial situation. Consolidating is a good idea if you have multiple, high-interest debts or have a good credit score and want to streamline your payments. However, it may not be a good idea if the new interest rate offered by the lender is higher than your current loans, leading to a higher monthly payment that’s more difficult to manage.
No, you are not required to close any credit card account if you simply want to consolidate the debt. Debt consolidation only transfers your remaining balance onto one new card or loan, but it doesn’t automatically close an account. If you pay off other loans with your debt consolidation, they may be closed and marked “paid as agreed,” depending on the parameters you agreed to when you accepted the loan originally. Read your loan agreements to find out what applies to you.
Since debt consolidation loans are often unsecured personal loans, your lender will have the right to sue you in court. Not only this, but lenders will report you to the credit bureaus, which can lower your credit score significantly.
sources
- Experian. "How Long Do Settled Accounts Stay on a Credit Report?." Accessed January 17, 2023.
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