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Do you have a mountain of debt looming over you — various credit card balances, medical bills, and installment loans that have piled up? If you’re ready to take the reins and turn the situation around, a debt consolidation loan may be able to help. But it won’t be right for everyone. Debt consolidation can possibly lower your interest, but it may not lower your overall costs. 

Pros of debt consolidation

Debt consolidation can be a helpful solution when you’re juggling multiple debts and want to streamline repayment. Here are a few of the top reasons why.

Potentially lower interest rates

If you have high-interest debt, a debt consolidation loan with a lower interest rate can help to lower your borrowing costs. For example, Americans carrying credit card debt pay an average annual percentage rate (APR) of 20.68%, while the average APR on a 24-month personal loan is just 11.48%, according to the latest data from the Federal Reserve. 

For example: Let’s say you had $5,000 of credit card debt with an average APR of 22% and a monthly payment of $150. Your overall interest would be $2,798, and you’d end up paying $7,798 over the course of four years. However, if you were to consolidate that debt into a personal loan with a 12% APR and a loan term of five years, your monthly payment would decrease to $111, and your overall interest would be $1,673. You’d end up paying $6,673, with a savings of $1,125 in interest over the life of the loan.

Simplified payments

Managing multiple debt payments each month can be stressful and time-consuming. It also increases the likelihood that one of your payments will eventually slip through the cracks. Debt consolidation combines multiple debts into a single loan, which streamlines your payment process — you’ll just need to remember one amount and one date per month. 

Can pay off debt faster

Debt consolidation can also help you pay off debts faster because you’ll combine them all into a single installment loan with a monthly payment and a set term. It can be harder to see the light at the end of the tunnel when you have multiple revolving credit lines that only require minimum monthly payments.

Improved credit score

If you’re using a debt consolidation loan to pay off credit card balances, your credit utilization rate will drop, which will likely result in a significant credit score boost. 

Credit utilization is based on revolving account types like credit cards and lines of credit, so your new installment plan won’t count toward it. Additionally, consistently making on-time payments on your new loan will help to move your credit score in the right direction.

Cons of debt consolidation

Here are a few of the downsides of debt consolidation loans. 

Potential for higher overall costs

Unfortunately, there’s no guarantee that a debt consolidation loan will end up lowering your borrowing costs. Those with fair-to-poor credit scores (a FICO score below 670) may find that they can’t qualify for a rate that would justify undergoing debt consolidation. You’ll need to run the numbers on your current debt costs and the costs of a debt consolidation loan to see if the savings are there or not. Additionally, consolidating your debt with a loan that has a longer repayment term will likely cost you more in interest in the long run.

Risk of taking on more debt

Paying off your credit cards and other debts with a consolidation loan can help to improve your credit scores, but it can also leave you with newfound credit available. If you don’t change the habits that got you into debt, you risk acquiring more, which can leave you with an even bigger problem.

Negative impacts on credit scores

While the end goal is to pay off your debt and improve your credit reports and scores, you may see initial drops. Here’s why:

• Hard inquiries: When you decide to move ahead and apply for a loan, a hard inquiry (credit check) will be required, which hurts your credit scores and stays on your credit reports for 1 to 2 years, depending on the credit scoring system. 
• New loan account: Consumer credit bureaus look at the age of your credit accounts, and a new, larger account will lower your average account age and could cause a drop.
• Delays in reporting: It can also take 30 days or more for lenders to report the accounts you paid off to the credit bureaus, which can delay the positive impacts of the debt consolidation. 

Limited options depending on financial profile

When you apply for a debt consolidation loan, lenders typically look for a reliable income source and a good payment track record. They want to ensure they’ll get their money back and earn a profit. 

To get approved for a loan large enough to consolidate multiple debts at a competitive rate, you’ll need to have good credit and steady, verifiable income (in a high enough amount). If you don’t, you may have trouble getting approved. 

How to apply for a debt consolidation loan

Various types of financial institutions offer debt consolidation loans, including banks, credit unions, and alternative lenders. In many cases, you can apply online and get an answer the same day. Here’s how it works:

• Shop around: Search for reputable companies offering debt consolidation and personal loans. Look for offers that suit your needs in terms of the loan amount, APR, eligibility requirements, prequalification process, and customer service ratings. Make a short list of three to five companies that look to be a good fit.
• Get prequalified: Request quotes and get an estimated interest rate from each of the companies on your shortlist without a hard credit check. Instead, lenders will perform a soft credit pull, which doesn’t affect your credit. But once you submit an application, it can trigger a hard credit pull and temporarily lower your score slightly. You’ll often need to provide information such as your name, address, birth date, annual income amount, and Social Security number. Prequalification is not an offer of credit, so your final rate offered by a lender could be higher than it was estimated.
• Compare quotes: Take note of the rates and terms that each company estimates and compare them side by side. Review the loan amounts, monthly payment amounts, interest rates, fees, loan term lengths, and overall costs. You may also want to consider ancillary factors like discounts, customer service ratings, and hardship programs. 
• Get qualified: Once you find the loan that looks like the best of the bunch, run the numbers to ensure it’ll offer you an advantage over your current payment plans. If it does, follow the company’s next steps to get officially qualified. In many cases, you’ll need to submit proof of income via tax returns or bank statements, provide more details about your previous answers, and agree to a hard credit check. 
• Receive official approval: If approved, you’ll be presented with the final rates and terms of your debt consolidation loan. If all looks good, you can sign the loan documents and wait for the funds to be deposited into your bank account. 

Is a debt consolidation loan right for you?

A debt consolidation loan can be a great solution if it reduces your interest costs, streamlines your payments, and helps to improve your overall financial situation. For example, if you have good credit and want to pay off multiple high-interest credit cards, it could make sense. 

On the other hand, debt consolidation typically won’t be the best route if your credit is in rough shape or you don’t have enough income. Lenders may deny your applications or approve them with low loan amounts and high-interest rates. It’s also a high-risk choice if you think you’ll be tempted to run up your credit card balances again. 

Alternatives to debt consolidation

If debt consolidation doesn’t sound like the best move, you can consider other options, including: 

• Debt management plans: You can hire a reputable credit counseling organization to work with your creditors and create a payment schedule. Then, you’ll deposit money with the agency each month and they’ll pay your outstanding bills, debts, and loans according to the plan. You can find nonprofit credit counseling agencies through the National Foundation for Credit Counseling. 
• Debt settlement: Debt settlement refers to settling a debt for an amount that’s less than the total amount you owe. You can contact your creditors and attempt to negotiate down your balances yourself, or you can hire a debt settlement company to do it on your behalf. However, be sure to read the Consumer Financial Protection Bureau’s warnings if you plan to take the latter route, as debt settlement usually requires you to miss your payments in order for the company to negotiate with your creditors. Your credit score can be impacted as a result, and it could lead to legal action from your creditors.
• Bankruptcy: When all other attempts to pay off your debts fail, you can look into filing bankruptcy. While a bankruptcy case will stay on your record for seven to 10 years, it can help you to discard or repay your debts and get a fresh start. However, this option should be considered a last resort.

FAQ

Will debt consolidation hurt my credit score?

Debt consolidation can cause a temporary drop in your credit score due to the hard inquiry that’s required to get the loan and the addition of a new loan with a large outstanding balance. However, your score should recover and improve once the various debts are paid off, your credit utilization drops, and you begin making on-time payments on the new loan. 

Can I consolidate my student loans with a personal loan?

No. Most lenders restrict you from using your personal loan funds to consolidate your student loans. However, you can consolidate your student loans separately by refinancing a private loan or consolidating a federal loan into a Direct Consolidation Loan from the federal government. 

Can I consolidate all types of debt?

You can consolidate many types of debt as long as they aren’t associated with illegal activities. Lenders don’t typically review your debts or pay them off for you. You request the loan in an amount that will cover your debts and then use the funds to pay them off yourself. However, there are lenders that will pay off your creditors directly. 

Can I still use my credit cards after consolidating my debt?

Yes. If you pay off your credit card balances using a debt consolidation loan, you’ll be able to use the cards to make purchases up to your available credit limits. But keep in mind that continuing to use your credit cards could dig you into a deeper debt hole and negate the main benefits of debt consolidation. 

How long does it take to pay off debt through consolidation?

The amount of time it takes to pay off your debt through debt consolidation will depend on multiple factors, including the total amount you owe, the monthly payment amount you can afford, and the rate you can get on a debt consolidation loan. 

What happens if I miss a payment on my consolidation loan?

Lenders vary in how they respond to missed payments but will often contact you about the late payment and request you get up to date as soon as possible. Late fees may apply. 

If the payment remains unpaid for 30 days or more, lenders will usually report it to one or more of the consumer credit bureaus, which will negatively impact your credit score for seven years. Continued late payments can result in lenders sending the account to collections or suing you to recover the balance. 

If you’re unable to make a payment, it’s best to contact the lender as soon as possible to try to make payment arrangements and avoid any negative repercussions.

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