A debt consolidation loan rolls multiple balances into a single, new one that typically has a lower interest rate than those on your existing debt. It also comes with a set repayment schedule, which can help keep you motivated to pay it off. However, it can backfire if you add to the loan or fail to make payments on time.
Debt consolidation loans are available through lenders like banks, credit unions and online lenders. You can even use a home equity loan, 401(k) loan or personal loan from a family member or friend to reduce your debt. However, not all types of debt are eligible for debt consolidation, and you’ll need to evaluate features like the type of loan, its term and whether it requires collateral.
Generally, you’ll apply for the debt consolidation loan with a lender that offers loans with the best rates based on your credit score and other factors. Your debt-to-income (DTI) ratio, which is your monthly debt payments divided by your income, is another factor lenders consider when offering you a debt consolidation loan.
Once you’re approved, the lender will distribute loan funds. You’ll then pay off your creditors and use the money left over to repay your debt consolidation loan with fixed, equal payments over a specified term.
You can opt for secured debt consolidation, in which you put up an asset like your car or home as collateral to secure the loan, or unsecured debt consolidation. Unsecured debt consolidation is the more common option, but it’s not a good idea if you have a low credit score or can’t afford to lose your assets. Instead, try making your credit card payments on time to raise your score before you try a debt consolidation loan.
The benefits of a debt consolidation loan can outweigh the drawbacks, but there are some important things to consider before taking this route. For example, the debt consolidation loan may be a bit more expensive than your original credit card debt, especially if you choose a longer term or higher interest rate. And, while consolidating your debt can help reduce your monthly payment, it won’t necessarily pay off your debt any faster.
In addition, if you don’t pay your debt on time, you could damage your credit further and increase the amount of debt you have to repay. It’s also not a good idea to take out new debt while you’re consolidating your existing credit card balances. The more you borrow, the longer it will take to pay off the debt and reduce your overall DTI ratio. For these reasons, it’s a good idea to speak with a financial professional before you pursue a debt consolidation loan. Getting pre-qualified online can help you understand your options and determine the best approach for your unique situation.