What Is a Debt Consolidation Loan?
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What is a debt consolidation Loan?
A debt consolidation loan will combine your current debts into one, usually with a lower interest rate and a shorter time frame to payoff.
Last updated on Dec 20, 2022.
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It is the loan that is used to consolidate the debts you have already incurred into one debt, with one monthly payment. The use of a debt consolidation loan will lower the amount of interest you owe on the debt and assist to pay it off more quickly. This can also make paying down debt simpler, as you only have one monthly installment to consider in your budget.
The rates and options of debt consolidation loans depend largely on your credit score: The better your score, the more options you have and the lower interest you’ll pay.
What are the ways debt consolidation loans perform?
Debt consolidation loans work by paying off your current debts with one lump sum. The amount of loans typically ranges from $1000 to $50,000 and repayment terms of two to seven years.
Let’s take an example. For instance, suppose that you own four credit cards each with a $5,000 balance. Instead of making monthly installments on each credit card you take out an installment loan worth $20,000 and then apply that cash to pay off your credit card debts. There’s only one monthly payment for your new loan.
Pros and cons of debt consolidation loans
Debt consolidation loans can be lifesaver for those sinking into high-interest debts, as they typically offer lower interest rates than most credit cards, based the credit scores of your.
For instance, the average interest rate for credit cards in the third quarter of 2022 was 18.43 percent, while the average interest rate for personal loans for two years loan during the same period was 10.16 percent, as per the Federal Reserve.
You can save money on interest costs, and you can apply the saving to the loan to help to pay off debt much quicker. Consolidated debt can also be easier to manage, since you only have to keep track of only one, set monthly repayment.
However, debt consolidation doesn’t come without its cons. Borrowers with bad credit (629 credit score or lower) may not qualify to receive a rate of interest lower than the ones on their current debts. If you qualify, you must still keep up with a monthly installment. If you fall behind you could be assessed a late fee and the missed payment may be reported to credit agencies, affecting your score on credit.
Consolidating also won’t solve habitual spending. It may even increase the problem because your credit cards will be re-freed.
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Is debt consolidation loans a good idea?
The consolidating debt loan is typically an excellent option if you can get one with a lower annual percentage rate than the total rate on your current debts, and also make the monthly payments.
Use NerdWallet’s tools to plug in your existing credit score and debts to see your consolidation options. You can also estimate your savings potential with the help of a loan for debt consolidating loan.
Do debt consolidation loans hurt your credit score?
Like all types of credit, one debt consolidation loan can have an impact to your score once you apply and after you pay it off.
If you are applying for the debt consolidation loan the lenders typically require an accurate check of your credit report, which could temporarily reduce your credit score by a couple of points. If you take advantage of those loans for the purpose of paying off credit card debt but end up carrying high balances on the cards after paying off the loan, your credit score could drop.
But it is a good thing it is a good thing if you are able to prove that the loan puts you in a better position because it allows for more manageable payments that you can make on time each month -that accounts for more than three-quarters of credit worth -and then using the loan and a temporary credit score dip might be a good idea in the long term.
How do you qualify for an debt consolidation loan
The likelihood of being able to get the debt consolidation loan is largely dependent the credit scores of your as well as your credit history. Creditors with excellent or excellent credit (690 credit score or higher) as well as a small amount of debt, and high incomes typically have the best rates on debt consolidation loans and also have a greater choice of lenders to choose from.
People with fair or poor credit (300 to 689 credit score) are viewed as riskier by lenders. They may not be eligible for debt consolidation loans from lenders who target those with bad credit.
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The best way to learn if you qualify for a debt consolidation loan is to look through the . One of the advantages of the pre-qualification process is that it utilizes an easy credit pull that provides you with a picture of loans and rates available to you without harming your credit score.
You can also examine loans from online lenders.
How to get a debt consolidation loan
Take a list of your debts as well as the monthly payments you wish to consolidate. The credit consolidation loan you take on must be sufficient to cover the debts you have, and the loan’s rate of interest and monthly payment amount must be less than the amount you’re currently paying.
Be sure that the loan payment is within your budget. A debt consolidation loan won’t be helpful if it ends up putting you further into debt.
Check your credit score and what loan amount and interest rate you want to get, then look for and compare loans offered to you. Take a look, and each one of them has various benefits.
Find out if you’re pre-qualified for an individual loan and not impacting your credit score
Just answer a few questions to get personalized rates from a variety of lenders.
The amount of the loan
on NerdWallet
Another option to consolidate debt
typically, it involves getting a loan however, alternative options include refinancing using a 0% interest balance transfer credit card using the equity of your home, or tapping into savings from your 401(k) saving account.
A refinancing loan could be beneficial for less significant loans that you believe you’ll be able to pay off during the card’s no-interest promotional period, which usually lasts 15 to 21 months. You’ll probably need to have good or outstanding credit to be eligible.
If you own a house, you could also take advantage of the equity in your home to pay off debts. and may have lower interest rates, but when you stop paying then you may be forced to sell your house.
A few people opt to take out a loan from their employer-sponsored retirement account, known as a . This option usually gives you access to lower interest rates, but it also eats into the retirement savings.
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About the author: Jackie Veling covers personal loans for NerdWallet.
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