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Debt consolidation loans: What to know

Debt consolidation loans combine multiple debts into one loan, which can potentially save you money. Getty Images/iStockphoto

If you're struggling to manage debt on multiple credit cards, a debt consolidation loan could simplify your monthly finances and help you regain control. When you take out a debt consolidation loan, you pay off several debts and replace them with one single loan with one fixed monthly payment. You may even be able to lower your interest charges and monthly payment.

If this sounds like something that you would benefit from, consider speaking to a lender. You can obtain a debt consolidation loan offer today.

What is a debt consolidation loan?

A debt consolidation loan can be used to pay down multiple debts, including credit cards, medical bills and personal loans. Debt consolidation loans are a type of personal loan you can use to combine several high-interest credit cards with one lower-interest loan. 

You may qualify for a debt consolidation loan of up to $100,000 with flexible repayment terms typically ranging from two to five years.

Why would someone want a debt consolidation loan?

Taking out a debt consolidation loan may make sense if any of the following circumstances apply to you:

  • You want to pay less in interest charges. If you have several high-interest credit cards, you might consider consolidating the debt into one personal loan with a lower interest rate. According to recent data from the Federal Reserve, the average interest rate on a 24-month personal loan is 8.73%, which falls well below the average credit card interest rate of 16.65%.
  • You want a specific repayment date. Credit cards provide a convenient way to borrow and pay off debt as you go, but if you're only making minimum payments, you could stay in credit card debt indefinitely. For this reason, you may want a debt consolidation loan to follow a repayment plan for a specific term, with a specific end date when your final payment brings your balance to zero.
  • Your credit score is sufficient to qualify. While personal loans are available to borrowers with below-average credit, a higher credit score may qualify you for lower rates. Typically, the higher your credit score is, the lower the interest rate you may receive. As a general rule, you may qualify for favorable terms with a good credit score, which begins with a FICO Score of at least 670 or a VantageScore of 661 or higher.
  • You can pay off your consolidation loan in five years or less. Debt consolidation loans are installment loans with repayment terms usually lasting two and five years. Of course, the longer you pay the loan, the more you'll pay in interest. A debt consolidation loan might be a suitable option if you can minimize interest charges by paying off your loan in less than five years.

The benefits of a debt consolidation loan are multiple. Start saving money and get out of debt by exploring your loan options now.

How do you qualify for a debt consolidation loan?

The qualifications for debt consolidation loans vary by lender, but most lenders strongly consider the following eligibility factors.

  • Proof of income: Nearly every lender requires you to meet a minimum income requirement to prove you have the financial stability to make good on your loan. Minimum income amounts vary by lender, and you'll likely have to prove your income with paystubs, bank statements or tax returns.
  • Credit report and credit score: When a lender reviews your application for a debt consolidation loan, they'll typically pull your credit report and credit score to evaluate your history of managing credit. If your credit is below average, you may be better off taking steps to improve your credit before applying for a new loan.
  • Low debt-to-income ratio (DTI): Your debt-to-income ratio (DTI) is another important criterion lenders use to evaluate your ability to repay your loan. The ratio compares the total amount of your monthly debt payments with your gross monthly income. For example, if your gross monthly debt payments total $1,000 and your gross monthly income is $5,000, your DTI ratio is 20% (1,000/5,000=0.200). Aim for a DTI of 36% or lower for your best loan approval odds.
  • Collateral: Some lenders require collateral for larger debt consolidation loans, often in the form of home equity.

Be aware that some lenders charge a processing fee (also called an origination fee) ranging from 1% to 8% of the borrowed amount.

How do you apply for a debt consolidation loan?

Taking out a debt consolidation is easy and fast, and you can apply by following these five steps.

  • Shop and compare lenders. Comparing multiple loan offers can help you find the best debt consolidation loan to meet your needs. Many online lenders allow you to prequalify for a loan to gauge your approval odds and what interest rate you might receive. When you prequalify, the lender typically performs a soft credit check which doesn't affect your credit score. 
  • Choose your loan offer and lender. Consider loans with the best balance of low interest rates and fees, flexible repayment terms and attainable eligibility requirements. After reviewing several personal loan offers, select the one that best meets your needs.
  • Fill out a loan application. Once you choose a lender, submit an official application. You'll have to provide information about employment, income and how much money you want to borrow. Your lender may ask you to supply supporting documentation, including a government-issued ID, pay stubs, account statements and proof of residence.
  • Pay your debt. Once your lender approves your loan application, you must sign for the loan to release the funds. Your lender may disburse your loan funds directly to your competitors to pay off debts on your behalf. Alternatively, your lender deposits the money into your account and uses the funds to repay each of your debts.
  • Continue making payments. Upon loan approval, you're responsible for making payments on your new loan. However, it may take some time for your old creditors to close your accounts. To prevent damage to your credit, continue to make payments on your old accounts until they are formally closed.

Debt consolidation loan alternatives

If you don't want to take out a debt consolidation loan, there are other options to consider, such as:

  • 0% APR balance transfer credit card: These credit cards offer an interest-free period of up to 21 months. You can pay off as much debt as possible during the 0% interest promotional period, but understand these cards usually require good credit to qualify.
  • Home equity loan: You may be able to tap into your home's equity to pay off your outstanding debts. Generally, lenders allow you to borrow up to 80% of your home's value, minus your mortgage balance. Home equity loans involve considerable risk since you must offer your home as collateral.
  • Credit counseling: Instead of borrowing money to pay down your debt, you might consider getting credit counseling from a nonprofit agency. A counselor can help you establish a budget and devise a repayment plan. Some agencies will even contact your creditors to lower your interest rates. Online financial advisers can also help steer you in the right direction.

Whether you take out a debt consolidation loan or use another method, eliminating credit card debt can dramatically improve your financial health, but only if you can avoid piling up new debt and repeating the cycle. As a rule, never charge more than you can afford to pay off.

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