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If you have multiple loans and credit card debts, paying them on time every month and dealing with multiple interest rates can get complicated. A debt consolidation loan helps streamline the process by rolling multiple debt balances into one loan with a single interest rate and one monthly payment.

Learn what a debt consolidation loan is, the pros and cons of this strategy, what this type of loan offers, how to get one and which other options to consider.

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What are debt consolidation loans?

Debt consolidation loans are personal loans used to pay off credit cards and other types of loans. You can apply for a debt consolidation loan through online lenders, credit unions and banks for amounts up to tens of thousands of dollars. These are usually unsecured loans, meaning the lender won’t require collateral that it could take back if the loan goes unpaid.

Repayment terms for a debt consolidation loan vary, but you can expect to make a predictable loan payment each month. The lender usually offers a fixed interest rate, and the term can vary from one to seven years. Factors such as your credit history, the amount borrowed, the loan term and the particular financial institution all influence your monthly payment amount and interest rate.

Benefits of a debt consolidation loan

Getting a loan to consolidate debt offers benefits beyond just the simplicity and predictability of a single loan payment. Consolidating your debts can set you on a path to getting out of debt sooner and possibly saving on interest if you choose your lender wisely.

Your debt is combined into a single loan

Once you take out a debt consolidation loan, you’ll have one balance and one monthly payment. You’ll have less risk of forgetting one of your several loan payments and incurring late fees and damage to your credit. Having a single loan, it will be easier to budget for the payoff process and check how much of the loan still is unpaid.

Plus, a debt consolidation loan cuts the confusion that occurs when you have several interest rates on several different balances. If your individual debts have higher rates than your consolidation loan, you could even save money. You’ll have the best chance of getting a competitive rate if you have a high income and a low debt-to-income ratio.

A debt consolidation loan can help to pay off debt faster

If you want to escape debt faster, a debt consolidation loan could put you on the right track. Unlike credit cards with minimum monthly payments that can lead to an indefinite repayment time, a consolidation loan has the payment amount calculated so you repay your debt by a specific end date. This could help you be more disciplined, especially if you previously just paid the minimum on your credit card monthly payments.

A lower interest rate on your debt consolidation loan means you can speed up the repayment process. While the lower rate would mean a lower monthly payment, you could contribute extra each month, which goes directly toward paying down the principal. As a side benefit, you'll save on the amount you pay in interest: Over time, you'll pay less toward interest than you would pay if you hadn’t consolidated high-interest debts.

Drawbacks of a debt consolidation loan

The simplicity and potentially reduced repayment time with a debt consolidation loan will come with some disadvantages. These include fees for taking out the loan and the possibility that the interest rate isn’t better than your existing debts.

Loans come with origination fees

When you take out a loan for debt consolidation, the lender usually makes you pay an origination fee that comes out of your loan amount. The lender sets this feed based on a percentage of the loan amount. Depending on the lender, the fee can be up to 10%. It covers the administrative work needed to process your loan.

This fee affects both the loan amount needed and the potential cost savings the loan offers. For example, you’ll need to ask for a higher loan amount to account for the origination fee. Plus, you’ll need to consider the fee alongside the potential interest savings to ensure a debt consolidation loan is worth it.

A debt consolidation loan may result in a higher interest rate

If you need a debt consolidation loan and you have bad credit or fair credit, the annual percentage rate (APR) offered can run high due to the risk the lender sees. In some cases, you could pay 30% or more, which can make APR increase your monthly payment, but it adds up substantially over a longer repayment term.

Shopping around and comparing repayment terms for multiple lenders is crucial. You might find it best to wait until your credit score improves so you can get a better debt consolidation loan APR.

How debt consolidation loans work

When you get a personal loan to consolidate debt, the lender usually provides the loan amount — minus the origination fee — as a lump sum deposited into your bank account. You will have the flexibility to choose which creditors to pay off and distribute the funds as desired. It usually takes up to a week to get the loan processed and deposited, so it’s important to keep up with any debt payments during the waiting period.

The repayment process begins with the first payment date the lender provides. You’ll simply pay each month until the loan’s end date, but you can also pay it off early. Keep in mind that lenders often charge fees for making late payments or for paying off the loan early, so be sure to review the loan terms carefully.

How to get a debt consolidation loan

Qualifying for a personal loan for debt consolidation requires meeting the lender’s criteria, including an acceptable credit score and debt-to-income ratio. You can obtain your credit score online, and inventory your debts and income sources to see how your financial profile looks before you apply. Even if you have some financial problems, you can likely still find lenders willing to work with you, but expect fewer options and higher interest rates.

Once you’re ready, you can usually apply online for a debt consolidation loan. Before you start, gather the information needed to complete the application. These pieces of information usually include proof of identification, a utility bill to verify your address, a recent pay stub or a bank statement to verify income, and cosigner information if needed. Some lenders have a preapproval form on their websites so you can compare terms without having a hard credit pull. Otherwise, you can submit an official application.

Review the loan terms carefully before you sign and submit the application. If you are approved, the lender should explain when you’ll receive the funds and when you need to make your first payment. You can try a different lender or use a cosigner if the lender denies your application.

What to try before you apply for a debt consolidation loan

Before seeking debt consolidation loan options, consider whether you can make your current debt payments more manageable on your own. Some potential steps include focusing on high-interest debt, lowering interest rates, effectively budgeting for payments or increasing the income available to put toward debts.

Pay high-interest debt first

High-interest debt is hard to tackle since only a small portion of your monthly payment might go toward the principal. Known as the debt avalanche strategy, putting extra toward high-interest debt payoff first saves you money and puts you in a better financial position to pay off other debts. Often, the main debts to target include credit cards, which tend to have higher interest rates than loans.

After tackling the high-interest debt, pay off the smallest balances first. Learn more about the debt snowball versus debt avalanche strategies to better understand these common approaches.

Negotiate lower interest rates

Shopping around and negotiating upfront with consolidation loan lenders are ideal tactics for getting competitive interest rates and saving money. Negotiating lower interest rates with existing creditors is also possible, especially for credit card debt.

Call the creditor and explain the need for a lower rate and reasons why the creditor should offer it. For the best chance, you should have a good payment history and a longstanding relationship with the creditor. Having information on competitors’ rates can help as well.

Create a budget plan

A budget is crucial for seeing where your money comes from and where it goes each month. Listing all your income sources and expenses lets you see how much you can put toward debt payoff as well as where to cut unnecessary costs. You can adjust the budget as you pay down debts or gain new income streams.

Creating a budget can seem complicated, but using a strategy such as the 50-30-20 rule can simplify the process. This method sets a target of 50% to be spent on needs, 30% for wants and 20% to go toward paying off debt and savings.

Increase your annual income

Your income determines how much can go toward debt repayment, so seeking extra sources helps. Depending on your current role, you could be eligible for a raise or have ways to boost your existing wages through commissions or bonuses. You could also take on a side job such as delivering food or working evenings at a store. If you have in-demand skills, consider doing freelance work or even creating a business.

Alternatives to debt consolidation loans

Debt consolidation loans have limitations that might mean they're not suited to everyone's situation. If you can’t qualify or if you owe a very high balance, you might prefer to negotiate with debt collectors and pay a partial amount. Another possibility is to take advantage of a balance transfer offer to avoid interest charges.

Consider debt settlement

If you want to pay less than your debt balances, debt settlement could accomplish this. This option involves either hiring a debt settlement company or calling creditors on your own and asking them to accept a partial repayment amount. Some creditors may agree to a flat amount or percentage of the balance, but there’s no guarantee. If you hire a company, you’ll pay a substantial fee for each debt settled.

Although debt settlement can save money and help avoid bankruptcy, it usually doesn’t remove negative items from a credit report. It can even further damage your credit score, and increase fees and interest if you stop making payments during the settlement process. There’s also the risk that a creditor will refuse to settle the debt.

Try a balance transfer credit card

Balance transfer credit cards let you transfer other credit card balances and certain loan balances to a new credit card. Like a debt consolidation loan, this option results in a single monthly payment and one interest rate. It can also offer the advantage of not paying interest charges if the credit card has a promotional period with a 0% APR.

After the promotional period, the remaining amount would incur interest based on the regular APR that the card terms specify. This makes a balance transfer credit card best for modest debts that you can pay off before interest charges apply. The card’s credit limit also determines how much debt you can transfer, so a loan is often a better option for consolidating large debt amounts.

Creditors usually charge a balance transfer fee for each balance transferred — typically about 3% to 5% of the amount you transfer, as well as any minimum fee amounts.

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Summary of a debt consolidation loan

A debt consolidation loan with a single monthly payment could help you better manage your finances and escape debt sooner. You'll have several factors to consider:

  • You'll likely have to pay an origination fee.
  • You may not get a competitive interest rate.
  • There are approval requirements you'll need to meet.

It’s important to investigate other options first and weigh the potential costs against the benefits.

If you go ahead with a debt consolidation loan, take the time to compare several lenders and search for a low-interest-rate debt consolidation loan. To avoid future financial and credit issues, make the consolidation payment on time and avoid taking on other debts when possible.

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