Debt consolidation with a personal loan

Rebecca Betterton

Key takeaways

  • Debt consolidation rolls two or more of your credit accounts into a single one, streamlining the repayment process.

  • Handling debt consolidation with a personal loan can help you pay off debt faster, as you'll get a fixed repayment term.

  • Borrowers with strong credit and high-interest debt are the best candidates for debt consolidation personal loans, as they could potentially save more money on interest by securing a lower rate.

Getting a personal loan to consolidate your debt can be a good way to simplify your financial life. When you take out a debt consolidation loan, you’re essentially rolling multiple monthly bills into a single account.

This can help keep your credit strong and make it easier to repay what you owe each month. That said, debt consolidation is usually worthwhile if you know you will spend less on interest than you already pay on your current debts.

What is the difference between debt consolidation and a personal loan?

A debt consolidation loan is a type of personal loan. Some lenders offer them as different products, but they follow the same principles. Both are fixed-rate installment loans that have a set monthly payment.

Personal loans

Personal loans are used for a variety of expenses — including debt consolidation. But they are not restricted to a specific use. If needed, you could use a portion of your personal loan for debt consolidation and another portion of it for an approved expense, like a home improvement project or to finance a big-ticket purchase.

Debt consolidation loans

A debt consolidation loan is a personal loan that has a specific purpose. In most cases, your lender will require you to use your loan funds to consolidate two or more debts and nothing else.

That’s because lenders often offer lower interest rates for this type of loan than if you were to get a personal loan to pay for a miscellaneous expense, such as a wedding or a vacation. With a debt consolidation loan, the lender will either pay you in a lump sum — so you can pay your creditors — or send the money directly to them to streamline the process.

How a personal loan works for debt consolidation

A personal loan is a debt product that can be used for almost anything. You’ll receive the funds in a lump sum and make monthly payments over a set period. These loans are usually unsecured, meaning they aren’t backed by collateral and don’t put you at risk of losing your assets. That said, because they don’t require collateral, credit requirements may be more stringent as the lender is taking on more risk.

Some consumers get personal loans and use the proceeds solely to consolidate debt, which is why you’ll often hear the term “debt consolidation loan.” Using a personal loan to consolidate debt involves paying off all your credit cards, loans and other unsecured debt, like medical bills, with the loan proceeds and making one manageable payment toward your loan each month until it’s paid off.

Credit Card Cash Back

Example:

To illustrate, assume you have the following credit cards:

  • Card 1 carries an APR of 15 percent, the minimum monthly payment is $25, and the outstanding balance is $500. (Time to payoff: 24 months; Total interest paid: $78)

  • Card 2 carries an APR of 17 percent, the minimum monthly payment is $30, and the outstanding balance is $750. (Time to payoff: 32 months; Total interest paid: $182)

  • Card 3 carries an APR of 19 percent, the minimum monthly payment is $35, and the outstanding balance is $1,000. (Time to payoff: 39 months; Total interest paid: $341)

If you take out a personal loan for $2,250 with a 36-month term and 10 percent interest rate, your monthly payment will be $73, slightly lower than you’re already paying. More importantly, you will only pay $363.64 in interest over the loan term — a decrease of $237.36.

Aside from saving you money on interest, personal loans can also help keep your accounts in good standing and preserve your credit score if you have multiple types of debt. Falling behind on any of your payments, whether for a credit card or student loan, can crush your credit score. It could also hinder your chances of borrowing money or getting competitive terms on debt products in the future.

Pros and cons of debt consolidation with a personal loan

While there are some benefits to using a personal loan to consolidate debt, there are a few drawbacks worth considering before applying for one.

Green circle with a checkmark inside
Green circle with a checkmark inside

Pros

  • A single account and payment due date to keep track of.

  • Potentially lower interest rates than credit cards.

  • Pay debt off faster through a set repayment schedule.

  • Predictable monthly payments, as interest is fixed.

  • Improve your credit score with on-time payments.

  • Reduce your credit utilization ratio when you consolidate credit cards.

Red circle with an X inside
Red circle with an X inside

Cons

  • High interest rates of up to 36 percent for those with poor credit.

  • Extra upfront costs, as many lenders charge an origination fee.

  • Paying off your credit balances could tempt you to rack up debt again.

  • Potential to increase your debt-to-income (DTI) ratio.

When to get a personal loan for debt consolidation

High-interest debt, such as credit card debt, might make you a good candidate for a debt consolidation loan since personal loans tend to have lower interest rates than credit cards. But aside from that, debt consolidation loans can be a good option if:

  • You have strong credit: The better your credit, the more likely you are to qualify for a loan at the lowest interest rate. The lower your interest rate, the less you have to pay on top of the money you borrow.

  • You have significant — but controlled — debt: If your debt is large, but you can make at least minimum monthly payments, a personal loan might work best for you.

  • You can stick to your budget: Before you get a personal loan, review your finances to make sure you can afford the loan and pay your debt both now and in the future.

When not to get a personal loan for debt consolidation

Although a personal loan for debt consolidation can help you save money and get out of debt faster, they’re not the right choice for everyone. These are some scenarios when a debt consolidation loan may not be the best alternative:

  • Your credit score is low: It’s possible to qualify for a personal loan if you don’t have great credit. Unfortunately, it’s highly likely that you’ll only qualify for steep interest rates, possibly making the costs of consolidating outweigh the benefits.

  • The rate you’re being offered won’t allow you to save money:  If the personal loan rates you’re offered are higher than what you’re paying on your debt now, try alternative methods for tackling your debt. Once your credit improves, you may qualify for debt consolidation loans with better terms.

  • You’re struggling to afford your minimum monthly payments: You could get a more affordable monthly payment by consolidating. However, if money’s already tight, you may struggle to make on-time payments, which could be detrimental to your credit.

Other ways to consolidate debt

If a debt consolidation personal loan doesn’t work for you, there are a few alternative ways to consolidate debt.

Home equity loan

If you own your home and owe less on your mortgage than the house is worth, you may be able to take out a home equity loan and use it to pay off your outstanding debt. A home equity loan is a type of second mortgage that allows you to borrow against your home’s equity. You can use the lump sum you receive from your home equity loan to pay off all your outstanding debt and then make a single payment on the new loan each month.

For home equity loans, your home is collateral. As a result, the lender views your loan as less risky, meaning interest rates are typically lower than unsecured loans such as personal loans. However, you could lose your home if you fall behind or fail to make payments on your home equity loan. Calculate your home’s equity to see if you’d qualify to borrow enough to cover your outstanding debt.

Balance transfer credit cards

You could try a balance transfer credit card if you want to manage a few credit card balances. Many cards offer 0 percent APR for a set amount of time, usually from 12 to 21 months.

This is a good way to move all your existing credit card debt into one manageable monthly payment. Remember that if you have a lot of credit card debt, you might not get approved for a balance transfer that’s the full amount you need to move over. That means you could be paying off your new card balance and any cards that couldn’t get moved over.

If you don’t pay a balance transfer credit card off before the 0 percent APR period ends, the card issuer starts charging interest, often at a high rate.

The bottom line

Using a personal loan to consolidate debt can be a smart choice if you’re juggling multiple high-interest credit accounts, as it can streamline your payments and save you money on interest. But for this to work, you’ll need a strong credit score and sufficient income. Otherwise, you may not be able to save in interest long term.

To maximize your savings potential, make sure to compare quotes from different lenders by prequalifying, as this allows you to view your offers without hurting your credit.

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