How to Consolidate Personal Loans: Steps and Tips

Debt consolidation involves combining multiple debts into a single loan. Typically, you can consolidate various high-interest debts, such as credit cards, medical bills and even personal loans. You may benefit from a lower monthly payment, reduced interest costs and a simplified repayment process.

While the benefits of consolidating personal loans are appealing, there may also be risks like extended repayment periods and additional fees. A thorough understanding of how and when to consolidate personal loans will help you determine if this is the best path for you.

Key Takeaways

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Debt consolidation involves taking out one big loan to combine multiple debts into a single payment, ideally with a lower effective interest rate.

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You can consolidate your debt by taking out a new personal loan, using a balance transfer credit card or tapping into your home’s equity.

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Consolidating debt is a good idea only if you have several high-interest debts, have improved your credit score or want to reduce your monthly payments.

What Is Debt Consolidation?

Debt consolidation involves combining multiple debts into a single payment to simplify your financial management. It can help you save on interest and reduce the stress of keeping track of multiple due dates. A debt consolidation loan is a type of personal loan specifically designed for this purpose, which you can get from banks, credit unions or online lenders.

How Does Consolidating Personal Loans Work?

Consolidating personal loans might be a good idea if you have high interest rates, different due dates and widely varying payment amounts. Consolidating your debt simplifies your finances by reducing the number of monthly payments and lowering your overall interest rate, ultimately saving you money over time.

How it works: you take out a new loan that is enough to cover the total balance of all your personal loans you want to consolidate. Once approved, you can use the funds to pay off your existing personal loan debts. Then, you start repaying the new loan according to the agreed terms. During this period, staying on track with your payments is wise to avoid additional fees and interest.

Pros and Cons of Consolidating Personal Loans

Consolidating personal loans comes with both benefits and drawbacks. Understanding both can help you decide if this is the best option for your particular situation.

Key Takeaways

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PROS

  • Simplified Payments: Consolidating personal loans means you only have one monthly payment to manage instead of multiple payments.
  • Lower Interest Rates: You can secure a lower interest rate with a consolidation loan, which can save you money over time.
  • Improved Credit Score: Consistently paying off a consolidation loan can boost your credit score by showing responsible debt management.
  • Reduced Monthly Payments: Consolidating your loans can lead to lower monthly payments, making it easier to manage your budget.
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CONS

  • Extended Repayment Period: Consolidating loans can extend your repayment period, meaning you might pay more in interest over time.
  • Fees: Some consolidation loans have origination fees or other costs that can increase your overall debt.
  • Risk of Higher Interest Rates: If you have poor credit, you might end up with a higher interest rate on the consolidation loan than on some of your original loans.
  • Potential for More Debt: Consolidating loans can create a false sense of financial relief, leading to new debt accumulation if spending habits aren't controlled.

Ways to Consolidate Personal Loans

There are several ways to consolidate personal loans, including getting a new loan, using a balance transfer card and tapping into your home’s equity.

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GET A DEBT CONSOLIDATION LOAN

A debt consolidation loan allows you to combine multiple loans into one with a single monthly payment. Your creditworthiness will often affect the interest rate and loan terms you receive. Once approved, use the funds to pay off your existing debts.

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USE A BALANCE TRANSFER CREDIT CARD

With a balance transfer credit card, you can transfer multiple loan balances to one card, often with a low or 0% introductory interest rate. Apply for a card that offers balance transfers and, upon approval, move your existing loan balances to the new card. This can reduce your interest costs if you pay off the balance before the introductory period ends.

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TAP INTO HOME EQUITY

You can use a home equity loan or home equity line of credit (HELOC) to consolidate personal loans. Apply for a home equity loan or HELOC through a bank or mortgage lender. Once approved, use the funds to pay off your personal loans, consolidating them into a single loan secured by your home.

How to Consolidate Personal Loans

Remember that when you consolidate debts in general, you want a final effective interest rate that is as low as possible. However, you also need to be cautious of the repayment period, as you could end up paying more if you extend the period for too long. Here are some steps for a smooth consolidation process:

  1. 1
    Evaluate your current loans

    List all your personal loans, including balances, interest rates and monthly payments. This helps you understand the total amount you need to consolidate and the effective combined terms of your current loans.

  2. 2
    Check your credit score

    Review your credit report to know your credit score. A good credit score can qualify you for better interest rates and loan terms.

  3. 3
    Choose a debt consolidation option

    Decide whether to use a debt consolidation loan, a balance transfer credit card or a home equity loan. Each option has different benefits and requirements based on your financial situation.

  4. 4
    Compare offers

    Shop around and compare offers from various lenders, including banks, credit unions and online lenders. Look for the best interest rates, terms and a lack of additional fees.

  5. 5
    Submit your application

    Once you choose the best offer, complete the application process with the selected lender. Provide all necessary information, including details about your existing loans, income and credit history.

  6. 6
    Make monthly payments

    After consolidating your loans, ensure you make the monthly payments on time. This helps you stay on track with your new loan and can improve your credit score over time.

Is Debt Consolidation Right for You?

While debt consolidation can be beneficial, it isn’t ideal for every person or every financial situation. Seek out credit counseling or debt consultation services to determine your best path forward. There might be other programs that you can take advantage of to pay down your debt.

When Consolidating Is a Good Idea

  • If you have several high-interest loans: Consolidating can reduce your overall interest costs by combining high-interest loans into one with a lower rate. This saves you money over the life of the loan.

  • If you have improved your credit score: With a higher credit score, you can qualify for a loan with more favorable terms. This includes lower interest rates and better repayment options.

  • If you want to secure better loan terms: Consolidating can help you secure better loan terms, such as lower interest rates or longer repayment periods. This makes your debt more manageable and less expensive over time.

If you need to reduce the number of loans you’re managing: Consolidating multiple loans into a single payment simplifies your finances. It also reduces the risk of missing payments and incurring fees while stabilizing your cash flow.

When Consolidating Is a Bad Idea

  • If your credit score has not improved: Consolidating personal loans might not be beneficial if your credit score hasn't improved since you may not qualify for better interest rates or loan terms. This could lead to a consolidation loan that doesn't offer significant savings.

  • If you can't afford the new loan payment: It's a bad idea to consolidate if the new loan payment is beyond your budget. Struggling to make payments can lead to additional fees and potential damage to your credit score.

  • If the interest rate offered is too high: Consolidating is not a good idea if your new loan’s interest rate is higher than the effective rate of your existing loans. This would increase your overall debt costs instead of lowering them.

DEBT CONSOLIDATION ELIGIBILITY

Eligibility for a consolidation loan can vary depending on the lender, but lenders typically consider the following:

  • Credit Score: Lenders generally prefer borrowers with good credit scores (670 or above). Some lenders may offer consolidation loans to borrowers with lower scores, but these can have higher interest rates.
  • Debt-to-Income Ratio (DTI): This measures how much your monthly income is spent on debt repayment. Lenders generally prefer a DTI below 43%.
  • Income Verification: You'll likely need to provide proof of income, such as pay stubs or tax returns.
  • Existing Debt: Lenders will typically review your existing debt obligations and may have minimum loan amounts for consolidation.

Note that student loans are generally not eligible for consolidation with a personal loan. Also, while you can consolidate some secured debts (e.g., car loans), it's typically less common. — Alvin Yam, CFP

FAQ About Consolidating Personal Loans

We answered some commonly asked questions about consolidating personal loans to help you decide if this option is suitable for your needs.

How does consolidating personal loans affect my credit score?

Can I consolidate personal loans with bad credit?

How long does it take to consolidate personal loans?

What types of debt can be consolidated with a personal loan?

Is debt consolidation the same as debt settlement?

About Zachary Romeo, CBCA


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Zachary Romeo is a certified Commercial Banking and Credit Analyst (CBCA), and the Head of Loans and Banking at MoneyGeek. Previously, he led production teams for some of the largest online informational resources in higher education, with over 13 years of experience in editorial production.

Romeo has a bachelor's degree in biological engineering from Cornell University. He geeks out on minimizing personal debt and helping others do the same through people-first content.


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