Managing multiple debts can feel like a relentless juggling act, with each bill vying for your precious extra cash. Fortunately, there’s a potential solution that can simplify the choreography: consolidating debt with a personal loan. This financial strategy can give you the chance to simplify your debts and put you back in control.
Debt consolidation can offer both immediate relief and long-term financial gains. It can help you reduce your interest rates and your monthly payment amounts to help you get out of debt faster. Here’s how consolidating debt with a personal loan works.
Key takeaways
A debt consolidation loan is a type of personal loan, designed to consolidate and repay existing debts.
Debt consolidation simplifies your financial life by combining multiple debts into a single, consistent monthly payment to a single lender.
After you consolidate, it’s critical to maintain responsible financial habits while you repay your new personal loan.
Personal loan vs debt consolidation loan: What’s the difference?
A personal loan is a type of debt consolidation loan. These loans can help people manage their debt more effectively. Here’s how they work:
What is a personal loan?
A personal loan is a type of loan that can be used for various purposes, including home improvements, medical expenses, or debt consolidation. It is usually an unsecured loan, meaning it doesn't require collateral.
With a personal loan, you receive a lump sum of money upfront, then repay it over a fixed period of time, typically in monthly installments with a fixed interest rate. The funds from a personal loan can be used at your discretion, and there are generally no restrictions on how you use the money.
What is a debt consolidation loan?
A debt consolidation loan is a type of personal loan designed to help people pay off and merge their existing debts into one single loan — essentially a DIY refinance. This involves taking out a new loan to pay off multiple debts, such as credit card debt, payday loans, or other high-interest loans. Instead of making multiple loan payments to different creditors each month, a debt consolidation loan allows you to make one monthly payment to a single lender.
The primary goal of a debt consolidation loan is to streamline your debt and potentially secure a lower interest rate, which could save you significant money over time. It's worth noting that while all debt consolidation loans are personal loans, not all personal loans are debt consolidation loans. The main difference between these two is that personal loans can be used for a wide range of purposes beyond debt consolidation, while debt consolidation loans serve the specific purpose of consolidating and repaying existing debts.
The pros and cons of consolidating debt with a personal loan
Debt consolidation can be helpful, but it’s not for everyone. Carefully consider these pros and cons to decide whether consolidating debt with a personal loan is the right choice for you.
Pros of debt consolidation with a personal loan
Simplified repayment: One of the primary benefits of debt consolidation is the ability to streamline your debts into a single monthly payment. Instead of juggling multiple payment due dates and amounts, you can focus on making one fixed payment to a single lender.
Potentially lower interest rates: If you have high-interest debts, such as credit card balances or payday loans, consolidating them with a personal loan may allow you to secure a lower interest rate, which can save you a significant amount of money in the long run. You may also be able to get a lower interest rate if your credit score has improved since you took out your original loan.
Fixed monthly payments: Personal loans often have fixed interest rates and clear repayment terms. That means you'll know exactly how much you need to pay each month and when you can expect to become debt-free. This can help you create a clear budget and financial timeline.
Manageable monthly bills: Since personal loans often have longer loan terms than other financing options, your repayment period is spread out over more months, translating to lower monthly bills.
Cons of debt consolidation with a personal loan
Risk of accumulating new debt: When you use a consolidation loan to pay off existing debts, you’ll have more credit available to use on those accounts. Without responsible financial habits, though, you may be at risk of accumulating new debt while still repaying the personal loan. Remember –– even though you’ve paid off all your outstanding debt with a personal loan, you’re still only replacing that debt with a different type of debt. It is essential to exercise discipline and avoid falling back into old spending habits.
Potential origination or prepayment fees: Some lenders, including banks, credit unions, or online lenders, charge origination fees at the outset of the loan, which can add to its cost. Additionally, certain loans may have prepayment penalties if you choose to pay off the loan early. Be sure to carefully review the loan terms and any associated fees before proceeding with a debt consolidation loan.
Impact on credit score: Initially, applying for a personal loan may result in a temporary dip in your credit score due to the hard credit inquiry on your credit report. However, by making timely debt payments and reducing your debt load, your score should recover and potentially improve in the long run.
Harder to qualify for: Since most personal loans are unsecured, they’re riskier for the lender than secured loans are. For that reason, you generally need a good credit score to qualify for an unsecured personal loan.
How to get a debt consolidation loan
If you find yourself juggling multiple payments with high interest rates, debt consolidation may be right for you. Here’s how to get a debt consolidation loan.
Step 1: Assess your debt
Before you apply for a debt consolidation loan, compile a comprehensive list of all your outstanding debts. This may include credit cards, personal loans, student loans, or medical bills. For each loan, write down your outstanding balances, interest rates, minimum monthly payments, and due dates.
Next, Identify debts with high interest rates. These high-cost debts can wreak havoc on your finances and are therefore prime candidates for consolidation. If you don’t want to consolidate all your eligible debts, it may be worthwhile to prioritize those with the highest interest rates first. That’s because consolidating these can help you secure dramatically lower rates and, as a result, save you the most money.
Once you’ve added up the outstanding balances of the debts you intend to consolidate, you’ll have a better idea of what size personal loan you’ll need. Once you have this number, you’ll be able to use a loan calculator to estimate your monthly payments. Make sure you have the budget to comfortably make these payments.
Step 2: Pull your credit report
Lenders offer various loan products based on creditworthiness. Generally, the better your credit, the more options you’ll have.
An excellent credit score (typically 720 or higher) will qualify you for the lowest rates.
A good credit score (670-719) still allows you to access competitive loan rates.
A fair credit score (580-669) may limit your options for unsecured loans. Instead, you might want to consider a secured loan.
If you have poor credit (below 580), explore secured loans, cosigner arrangements, or credit-building loans may be necessary.
If you have bad credit, this may be the time to work on improving your credit score. Pay down current debts, make timely payments, and avoid taking on new debts. Make sure to obtain your credit report and check for errors. If you find inaccuracies, file a dispute to correct these before applying for a new loan.
Step 3: Compare lenders
It’s important to compare lenders to secure the best personal loan rates and terms. Here are the factors to consider when evaluating lenders:
Interest rates: Compare annual percentage rates (APRs) to understand how much your loan will cost with each lender.
Fees: Be aware of origination fees, prepayment penalties, or other charges that could affect your loan’s affordability.
Loan terms: Longer terms result in lower monthly payment amounts but higher interest costs over the life of the loan.
Customer reviews: Research a lender’s reputation by reading online reviews and looking for customer service ratings.
Personal loan marketplaces such as Navient Marketplace allow you to compare loan offers from multiple lenders. By inputting your information once, you can receive multiple personalized loan options based on your needs and eligibility. Comparing lenders through loan marketplaces can help you discover loans that align with your financial needs while saving you money in the long run.
Step 4: Get prequalified
Prequalification is a useful tool when you’re shopping for personal loans. It allows you to compare offers from different lenders without a hard credit check. (A hard credit check, or hard credit inquiry, happens when lenders formally review your credit report and can result in a small, temporary drop to your credit score.) Prequalification provides a rough estimate of your borrowing potential and helps you identify lenders and loan products that align with your financial situation and needs. It only involves a “soft credit check,” which doesn’t impact your score.
To get prequalified, you’ll need to provide some basic information to a lender, typically online or through a quick phone call. Once they’ve performed a preliminary evaluation of your financial situation through a soft credit check, they’ll give you an estimate of how much money you can borrow and at what interest rate. The interest rate you’ll prequalify for is usually based on factors like your credit history, income, employment status, credit utilization ratio, and debt-to-income ratio.
It’s important to note that prequalification is not a guarantee that you’ll be approved for a certain loan amount or interest rate. It’s simply an initial step that gives you an idea of what you may qualify for.
Step 5: Apply for the loan
Once you’ve selected a lender, it’s time to apply for the loan. Most lenders offer online applications for convenience. You’ll need to provide essential documentation, including proof of identity, income verification (such as pay stubs or tax returns), details about your outstanding debts, and bank statements. The application process usually takes anywhere from 15 minutes to an hour to complete, depending on the lender and the complexity of your financial situation.
After submission, the lender will review your loan application, conduct a credit check, and assess your eligibility. You can apply directly through the lender’s website, visit a physical branch, if available, or use a personal loan marketplace such as Navient Marketplace, that allows you to compare multiple lenders and complete applications from a single platform.
Step 6: Pay off existing debts
Once your loan is approved and the funds are disbursed, put the money to work by paying off your existing debts. Allocate the funds strategically, starting with high-interest debts like credit cards or payday loans. By doing so, you can reduce the overall interest you’ll pay and free up more money for other financial goals.
Step 7: Create a repayment plan
Resist the temptation to accumulate new debts while you’re working on paying off existing ones. To create a repayment plan that aligns with your budget, start by assessing your monthly income and expenses. Determine how much you can comfortably allocate toward repaying the consolidation loan without straining your finances.
Keep in mind that late payments could cost you fees, setting you back even further. Autopay can be a smart strategy to avoid this. Set up automatic transfers to your loan bank account on or just after each payday. Some lenders also provide a rate discount for borrowers who enroll in autopay.
Alternatives to consolidating debt with a personal loan
Consolidating debt can be done with more than just a personal loan. If you don’t think a debt consolidation loan is right for you, here are some other options to explore:
Balance transfer credit cards: These credit cards allow you to transfer high-interest credit card balances to a new card with a lower or zero percent introductory interest rate. This can help save money on interest charges while consolidating debt. The rates on these cards generally skyrocket after the introductory period and there may be a balance transfer fee, so pay off as much as you can before it ends.
Home equity loans and home equity lines of credit (HELOCs): If you own a home and have built up equity, you may be able to use a home equity loan or HELOC to consolidate debt. These loans allow you to borrow against the equity in your home and typically offer lower rates than personal loans. Keep in mind, these are secured loans backed by your house –– so if you default, the lender is within their rights to repossess your home.
Debt management plans (DMPs): DMPs are offered by credit counseling agencies and involve consolidating multiple debts into a single payment. The agency negotiates with creditors to potentially reduce interest rates and create a manageable repayment plan.
Debt settlement: Debt settlement involves negotiating with creditors to settle your debts for less than the full amount owed. This option typically requires working with a debt settlement company or negotiating directly with creditors.
401(k) Loans: If you have a retirement savings account, such as a 401(k), you may be able to take out a loan against it to consolidate debt. It's important to carefully consider the potential impact on your retirement savings and consult with a financial advisor before opting for this approach.
Peer-to-peer lending: Peer-to-peer lending platforms connect borrowers with individual investors who provide loans. This can be an alternative source of loan funding for debt consolidation, especially for those who may not qualify for traditional personal loans.
Shop debt consolidation loans on Navient Marketplace
Consolidating debt with a personal loan can be an easy way to refinance your debts and get back on track toward paying them off. However, it's important to approach this process with careful planning and research. Assess your debt, compare lenders, and calculate the total costs involved. Once you've made an informed decision, apply for the personal loan and use it to pay off your existing debts.
Ready to shop for a personal loan? With Navient Marketplace, you can compare lenders for free all in one place. Just enter a few details about yourself and get personalized results from debt consolidation lenders in minutes.