Personal loan for debt consolidation

Credit card delinquencies are on the rise, according to the Federal Reserve Bank of New York. In fact, 8.9% of credit card balances transitioned into delinquency in Q1 2024. If you're struggling to pay off credit card debt, you may be able to reduce your monthly payments and interest rate with a debt consolidation loan. But you should take action now, before your credit score takes a hit from late or missed payments.

What is debt consolidation?

Debt consolidation lets you combine multiple high-interest debts, like credit card debt, into one new debt. This is often done by taking out a personal loan. By combining multiple credit card balances into one balance, you can manage just one account and one monthly payment. Perhaps more importantly, you may be able to lower your monthly payments significantly via a lower interest rate and/or a longer repayment term.

Personal loans, on average, have much lower annual percentage rates (APRs) than credit cards — 12.49% for a two-year personal loan compared to 21.59% for a credit card, according to the Federal Reserve. That's more than a nine percentage point difference.

Debt consolidation example

For context, if you wanted to pay off a $10,000 credit card balance in two years, with a 21.59% APR, you'd have to pay $517 per month to do it, and you'd pay $2,402 in interest. However, if you moved that balance to a two-year personal loan with a 12.49% APR, you'd pay $473 per month and only $1,353 in interest — you'd have an extra $1,049 in the bank after two years.

Alternatively, you could choose a longer repayment term (typically up to seven years) to lower your payment further. Note that longer terms tend to have higher interest rates; you'll also be looking at a higher rate if you don't have good or excellent credit.

Debt consolidation rates and lenders

There's no shortage of lenders to choose from when you're shopping for debt consolidation loan options. But the first step is often to prequalify with several lenders in order to get an idea of the rates you might qualify for. Prequalification doesn't hurt your credit and only takes a few minutes, but it's not an offer of credit. And you'll need to provide some personal information to get customized rate quotes. When you're ready to move on with a formal loan application, the lender will conduct a hard credit pull, which could impact your score.

Best debt consolidation loans

How debt consolidation works

When you take out a debt consolidation loan, you typically borrow enough to pay off your debt. Then, you use those funds to pay off your different accounts. (Some personal loan lenders will send funds directly to your creditors, and may even give you a rate discount for doing so.) In essence, you replace multiple debts with one single debt, and one monthly payment. Note that you can use a personal loan to refinance credit card debt and other debt as well. In other words, you don't need to have multiple credit card or debt balances to benefit from using a personal loan to pay off debt. 

A personal loan for debt consolidation is typically an unsecured loan, meaning it's not backed by collateral, like your home or car. Most personal loans have a fixed rate and equal monthly payments for a set repayment term. Repayment terms often range from one to seven years, and loan amounts from $600 to over $50,000, depending on the lender and your credit profile and income. Personal loans are available from banks, online lenders, and credit unions.  

Personal loans tend to have higher APRs than secured loans like a home equity loan (but lower APRs than credit cards, on average). On the flipside, they're typically faster to get (a few days versus a month or more), and you don't put your home or other collateral at risk if you miss payments. 

Instead of using a personal loan or home equity loan, you could use a balance transfer credit card to consolidate debt. Some cards offer a 0% APR for a promotional period that often lasts from six to 21 months. However, these cards typically come with fees equal to between 3% and 5% of the balance transferred. 

Pros and cons of debt consolidation

There are several advantages to consolidating debt, particularly with a personal loan. But before you take the next step, consider both the benefits and drawbacks.

Pros

• Fewer monthly payments: If you have several debt accounts, it can feel challenging to manage multiple monthly payments and due dates. When you consolidate your debt, you can reduce the number of monthly payments to just one.
• A lower APR: Personal loans and home equity loans can have much lower APRs than credit cards. You may be able to save a lot of money on interest over the life of your loan by qualifying for a lower interest rate.
• Fixed repayment: Personal loans and home equity loans have fixed monthly payments and payment periods. You’ll always know when your monthly payment is due and the amount. Additionally, you’ll know exactly when your loan will be paid off. Debt such as credit cards, on the other hand, can have payments that change from month to month. Credit cards have variable interest rates, which can change depending on market conditions. The interest rate, in turn, can affect your monthly payment.
• Expedited debt payoff: If you get a lower APR, a debt consolidation loan may be able to help you pay your debt off faster. What’s more, because personal loans don’t have compounding interest like credit cards do, you don’t have to worry about your loan accruing interest on top of interest.
• Improved credit score: A debt consolidation loan can give your credit score a boost. Not only can you pay off your existing debts and lower your credit utilization ratio, but you’ll also get help when you make on-time, consistent loan payments.

Cons

• Loan costs: Loans come with fees, including application fees, origination fees, and late fees. These can add a lot to your total loan amount. The good news is some lenders offer no-fee personal loans, so keep that in mind as you search.
• Possibly higher APR: Personal loans may allow you to get a lower rate, but that’s not always the case. If you have a bad or fair credit score, you may find that the personal loan rate you’re offered is higher than the rate on your current debt.
• May not solve your debt problem: A personal loan can help you pay off your existing debt, but it may not remove the issue that got you into debt in the first place. Whether it was financial hardship or overspending that caused your debt to grow, it’s important to address it to ensure you don’t get into more debt by borrowing more.
• Could hurt your credit: If you miss payments or make them late, you could cause your score to suffer.

Comparing debt consolidation loans

Using a personal loan to consolidate your debt can be a great option, but consider the following before you apply:

• APR: Your APR is one of the most important factors to consider when comparing different loans. APRs account for both the interest rate and upfront fees the lender charges, expressed as an annual percentage of the loan amount.
• Loan amounts: Each lender has minimum and maximum loan amounts. Find a lender that offers the loan amount you need to pay off debt.
• Repayment terms: Personal loan repayment terms typically range from 1 to 7 years. A longer repayment term can result in a lower monthly payment, but also in more interest over the life of the loan.
• Fees: Lenders may charge origination fees or late fees, and closing costs, depending on the type of loan. Origination fees tend to be 0% to 12% for personal loans, depending on the lender. When comparing loans, look for those with no origination fees and low expenses.
• Customer service: While customer service may not be your top priority, it’s still a factor to consider. Having good customer service will be important if you run into problems with your loan down the road. Trustpilot and the Better Business Bureau are great resources to consider.

How to qualify for a personal loan

If you’re planning to apply for a personal loan for debt consolidation, consider the following requirements:

• Credit score: One of the most important factors lenders consider when you apply for a personal loan is your credit score. Lenders can have different minimum credit scores, but keep in mind that higher scores usually result in lower interest rates.
• Payment history: In addition to your credit score, lenders will look at everything else on your credit report. In general, they want to see that you’ve made on-time monthly payments on your other accounts so they can trust you’ll do the same with this loan.
• Reliable income: During the loan approval process, you’ll have to provide proof of income to your lender so it knows you’ll have the money to make your monthly payments. Income can include wages from your job, retirement and rental property income, and other recurring sources.
• DTI: Your DTI, or debt-to-income ratio (DTI), is the percentage of your monthly gross income that goes toward debt. The lower your DTI, the more room you have to add another monthly payment to your budget. A lower DTI can improve your chances of approval, as most lenders like to see this number below 35%.
• Cosigner: If you don’t meet your lender’s requirements for credit score, DTI, and other factors, you may need a cosigner to qualify for a loan. A cosigner is someone — usually a family member or close friend with good credit — who signs for the loan with you and agrees to make the payments if you don’t. Not all lenders offer personal loans with cosigners, however.

How to get a debt consolidation loan

Here’s the application process for a debt consolidation loan.

1. Check your credit score: Before you apply for a personal loan, you should know your credit score. Knowing your score can help you determine what loans you’ll be eligible for. And, if your credit score is on the lower end, you may decide to work on increasing it before you apply to get a better loan rate and terms. Visit AnnualCreditReport.com for a free credit report.
2. Consider your loan amount: An important step in consolidating your debt is determining just how much you need for debt payoff. Take some time to log into all of your debt accounts and get the total so you know how much you’ll need to borrow.
3. Shop around and prequalify: Prequalifying won’t impact your credit, which makes it a good tool to see an estimate of the rates, terms, and amounts you may qualify for from each lender. However, it’s not a guarantee of credit, and your final rate may be different. Consider getting prequalified with several lenders to compare your options.
4. Complete your application: Once you’ve decided which personal loan is best, you can officially apply. Once you do, the lender will perform a hard credit pull, which will impact your credit score temporarily. This process is more involved than the pre-approval process, as you’ll also have to submit proof of your income and financial situation.
5. Get your loan funds: If your loan is approved, you’ll receive your money to pay off your debts. Many lenders can typically disburse your funds as soon as the same or next business day after approval.

Other ways to consolidate debt (or pay it off)

A personal loan isn’t the only option to help you consolidate your debt. Here are a few other options to consider:

• Balance transfer credit card: If you have credit card debt, you may be able consolidate your debt using a balance transfer card. Many cards have introductory 0% APR offers that often last from six to 21 months. With this method, it’s key that you pay off the entire amount before the interest rate goes up to its standard (and usually much higher) rate once the promotional period ends. You'll also need to pay a balance transfer fee, which may range from 3% to 5% of the amount transferred and is added to the card's balance.
• Home equity loan or HELOC: Home equity loans or HELOCs — short for home equity lines of credit — are both lending tools that allow you to borrow against the equity in your home. Your home serves as collateral, meaning you can often get a lower interest rate than on an unsecured loan. However, it also means that if you can’t make your payments, your home is at risk. You'll need sufficient home equity to qualify. 
• Debt snowball or avalanche: While using another lending tool can help you to pay off your debt, you can also tackle your debt as it is. The debt snowball method can help you pay off your debt by focusing on your lowest balance first, while the debt avalanche method involves prioritizing your highest-interest debt first. The snowball method is great for those wanting to see progress quicker, while the avalanche method can save you more in interest.
• Credit counseling and nonprofits: If you feel like you need a bit of extra help paying off your debt, consider enlisting the help of a credit counselor. A credit counselor can help you take a deep look into your finances, figure out a repayment plan, and even offer programs like debt management plans. The National Foundation for Credit Counseling offers resources that can help. You can also contact 211 for local resources in your community.