Debt consolidation loans
Let’s say you are overwhelmed by a number of pending debts, probably because you hold multiple credit cards to payoff: each card has its due date, rates are high, and you can’t keep up with all those payments and the hassle anymore. Fortunately, there is a solution: debt consolidation.
When you hear speaking of debt consolidation, it means you are merging more debts from various types of bills, most of the times being from high-interest credit cards, into a unique form of payment, which is fixed, done on a regular monthly schedule, and with a lower interest rate applied. The goal of this is to make you out of debt in a matter of a few years, stopping the chain of perpetuated debt you might be incurred from so many payments.
Debt consolidation, regardless of the way it is pursued, can include credit cards, medical bills, payday loans, and personal loans.
To accomplish this, any debt consolidation option, and there are several of them, must consist in a decreased rate, compared to what you were actually paying from credit cards or other account sources: your monthly payments should consequently be reduced, so that you can actually afford to payoff the total debt.
There are two fundamental ways for debt consolidation:
- With a loan: a personal loan the most used option, but there are also other types of loan discussed later.
- Without a loan: it can be done without the need to take a loan in its strict sense. A debt management plan (DMP) is specifically aimed to consolidate debts from credit cards and other kinds of outstanding debts.
What are you required to obtain debt consolidation?
In order to qualify for a debt consolidation loan or alternative plan, you will first need to ascertain that you can bear that newly set payment on a regular monthly basis. Lenders will look at things like your employment history, your income, and if it comes from a steady source, as well as your credit score, which is a relevant factor since it tells them how well you can manage both your past and recent debts.
That said, lenders will declare a minimum credit score requirement. To get the most out of a debt consolidation offer, you must shoot for a good to excellent score, that is to say, anything above 670. Below this and down to 580, you are in a range of a fair score: you have still a chance to get a reasonable rate, way lower than a credit card rate. A too low credit (below 580) will likely make you unable to qualify, or assign you a rate for which debt consolidation turns to be inconvenient. Another relevant parameter will be your debt-to-income-ratio (DTI), that is to say, what percentage of your income you are currently using to pay off debts: lenders will generally consider that it won’t exceed 50% to make you a qualified borrower.
As a rule of thumb, a high credit score plus low DTI should be your must-have combo, not only to obtain a loan for debt consolidation but with the most comfortable rate and term of repayment possible. This is the case of a good-standing borrower, with a steady and reliable source of income.
Instead, the credit score is not a requirement when you choose a debt management program.
Having positive home equity will be required for larger loan amounts eventually because granting you more money will pose a greater risk to lenders: they will want to secure your loan using a collateral asset.
What is debt consolidation like?
To better understand how debt consolidation may prove useful to you, we have put down some numbers.
Assuming a $15,000 debt accrued from four credit cards, with an average rate of 19.99%, and a resulting monthly payment of $640 including fees, here is a possible scenario for debt consolidation.
| Credit Cards | Debt Consolidation Loan | |
|---|---|---|
| Interest Rate (with fees) | 19.99% | 15.39% |
| Due payment | $639.37 | $522.85 |
| Term | 30 months | 36 months |
| Interest paid, including fees | $4,181.07 | $3,822.21 |
The noticeably lower rate applied to the loan, along with a more stretched term of repayment, would make you save more than $115/month, which equals to $1,380 per year, as well as roughly $360 savings on interest. The considered rate percentages are APRs, which means they should include the bulk of a lender’s fees, possibly the origination fee, although this varies, and should be checked when you evaluate your individual offer.
Compared to a personal loan, you would typically get a much better rate from a debt management plan. However, it depends: rates are comparable for a credit score of at least 650, whereas you can expect an 8% as average for a $15,000 loan, while for lower scores, especially under 580, you get drastically better rates from a DMP. In many cases, borrowers with bad credit seeking to consolidate debt are likely to find better overall conditions from a debt management plan.
What are debt consolidation alternatives to a personal loan?
Besides a personal loan, let’s also look at other available options for debt consolidation. Which financing solution you will choose will strictly depend on your individual situation, and to some extent based on your preferences. Each of the following will have its advantages and drawbacks.
- Credit card balance transfer. A credit card of this type allows you to move the balance carried from multiple high-interest cards on a unique account: you will benefit from an introductory period of 0% interest lasting 12 to 21 months, so to have the most temporary relief for managing at least a portion of your debts. This requires a transfer fee of usually 3 to 5% of the transferred balance, and a minimum 670 credit score: bad credit borrowers will likely be denied. Moreover, you still have the relatively short terms of a credit card to make the repayments.
- Debt Management Programs: these plans are meant to make you extinguish debt over the course of generally 3 to 5 years. They are operated by non-profit credit counselors that examine your situation and directly negotiate with credit card issuers or companies to obtain a reduced rate and lower monthly payments. The counseling agency uses these payments to pay off the companies, sometimes being able to waive additional fees, until settling up. The edge over any other solution is that you can obtain the lowest rate possible. However, you must be able to not miss payments to avoid cancellation of any granting, and you must close all your credit cards accounts, which will negatively impact the credit score; it will go up again as you make regular payments. Generally, a DMP has an 8%average rate, a $30-$55 monthly fee, plus a $75 setup fee for originating the service.
- Savings accounts, 401k loan. You have also the chance to tap into a saving account of yours or borrow from your deposited funds which were aimed at retirement. The latter case is known as a 401k loan: if your job allows creating a dedicated account, then you can draw money from it, with a low interest rate. But you will also have to pay taxes, and this decision will compromise to a degree your future financial safety in your old age.
- Home equity loan: if your home’s market value has substantially increased since you bought it so that you are paying less for it than how much is currently worth, then you have positive equity. You can borrow a great percentage from that differential amount (usually 80%) with relatively low interest (lower than a personal loan), using it to pay off your credit card bills. Terms are also longer, in fact they can be of 10 years, and beyond. Of course, this is a risky solution because here you are actually putting your house as a collateral asset in case of default.
- Debt settlement: there are profit companies that can settle your total debt, by dealing with your creditors. This is a faster way to eliminate debt, compared to debt management plans, but you will be charged way higher interest rates, along with steep fees, and eventual penalties for late or missed payments. Debt settlement will also rapidly decrease your credit score.
- Bankruptcy: in the extreme contingency where you become unable to repay your debts, it would be better to declare bankruptcy. This will make you lose all the credit cards and any belonging that is rightful to be sold to repay your creditors.
Some of these options might be indicated if you couldn’t qualify for a personal loan, which is the best compromise between all the pros and cons of debt consolidation. While you may find better terms of repayment, or lower rates (in the case of DMP), you must consider all the mentioned downsides to make your best choice.
How loans for debt consolidation work?
The most traditional way to consolidate debts is obtaining a specific personal loan from a credit union, bank, or online alternative lender. Taking such a loan means you have to choose a loan amount sufficient to cover all your pending debts: typically, that sum will be usually repaid in terms of 2 to 5 years, depending on lenders, and your circumstances.
It is crucial to have access to an interest rate which can be affordable to you, thus you must plan carefully your budget in advance. You should look at percentages significantly lower than the current ones applied to your credit cards, otherwise, you won’t get much out of a personal loan. They will greatly vary depending mainly on your credit score. A decisive factor is that this interest is of the simple type, and fixed, in contrast to a credit card interest which is compound and often variable: this adds both predictability and saving.
Rates for consolidating debt through a personal loan range widely: you can generally expect anywhere between roughly 6 and 20%, with low-credit borrowers being charged with the high-end percentages. Lenders will also charge fees, that ample degree of variation: an origination fee of 1-8% of the loan amount, and late fees of $15-$30 are the bulk of these costs.
You will find that lenders disclose APRs (annual percentage rates): under the same borrower’s conditions, a personal loan has generally significantly lower rates than a credit card. As mentioned, APRs may include some of the fees.
Again, lenders will look at the credit score, your annual income, and its source must be steady: they of course want to make sure you are prepared for your renewed commitment. While your goal is to get the lowest possible rate, you must still prove you are able to keep up with the monthly payments.
Using a personal loan for debt consolidation will make your credit card accounts stay open, which is a double-edged sword: you don’t have to give them away, but you might still be tempted to come back using them, worsening and complicating your debt.
Starting debt consolidation, regardless of the method, will make your credit score decreasing because you are basically creating another potential source of debt to extinguish previous debts. However, as you make a certain number of consecutive on-time payments, generally six months being considered a limit threshold, your score will increase again.
Is debt consolidation a good idea?
Holding credit cards is challenging because you need constant control and discipline with them. Management of payments can become hard, moreover, interest is compounded, which means you have interest on interest: this tends to create debt more often than not. Many people find appealing to make only minimum payments, but that will contribute to the debt, increasing the costs in the long run.
If you need to eliminate the burden of multiple outstanding debts from credit cards or other bills, and their costs, so that you can save money and spare you distress, then a personal loan or management plan are the ways to go.
They will have their initial own costs, but eventually, you will be able to save if you choose the right deal, not to mention the comfort of a single predictable lower monthly payment, instead of several high-interest installments. And you are likely to receive a longer term so that the payments are diluted over years.
In summary, here is what you should aim for:
- A decreased APR
- Lower monthly payments over a longer term
- Predictability
- Credit score improvement: a new well-managed single loan will positively impact your score.
However, there is no guarantee that you can obtain a more advantageous condition: sometimes fees may be steep, and you might not be able to bear those costs in the short term. Or, because of poor credit, you might not get a much lower rate. Another danger is extending too much the length of the loan because you will end up paying much on interest anyway.
Provided that you make on-time payments and finally extinguish your debts through it, a personal loan will also have the edge of making you increase your credit score, which will turn useful whenever you will need another financial service, such as a car loan, or mortgage refinancing, for instance.
That’s why it is crucial that you choose the right lenders: you can surely do your own research, but we recommend among the best personal loan companies: shopping around several offers is the best move to find what’s most suitable to you.
Besides, you must clearly understand you are willing to set aside credit cards and to renounce your old habits. This can certainly act as a brake, but financial wholeness is the priority here.
How do you choose the best debt consolidation loans?
When you are seeking a personal loan for debt consolidation, it is of the utmost importance to find companies that prove to be reliable while offering affordable rates and general conditions. Some companies can leverage low rates and no requirement of credit score to capture customers, but you must avoid these scams.
All you have to do is finding a lender, being a bank, credit union, or online provider: most lenders allow pre-qualifying offers, meaning you have the chance to compare multiple offers filling a one-time application. There will be only a soft credit check, but this won’t affect your score: you will see rates, terms, and loan amounts you are likely to obtain, before finalizing a loan. So, you can compare and decide which offer adhering, and going on with the final application. Only at this stage you will have to submit detailed documentation about your finances and will undergo a necessary hard credit inquiry.
Besides the APR, which must be significantly lower than your current one, you must consider if the terms of repayments are such that you can bear the monthly payments. You have also to consider your lender’s applied fees: the company must be transparent about those, since they will add to the cost of the loan, especially in the short term. Still, check if your lender is flexible about repayments: you can’t predict 100% you won’t face some hardship and might need some kind of deferment, or at least not being harassed by fees for few days of late payments.
Seek a friendly and professional customer service, so that you are readily supported by someone in person whenever you have doubt, at any stage of your loan. Customer satisfaction combined with an abundance of reviews is proof of the trustworthiness of that company.
We selected personal loan companies providing debt consolidation among the big names in the loans market: these are highly rated by thousands of customers, and will offer you the best rates on the market, reasonable terms, and an overall comfortable experience so that you can easily lighten your debt.
