Debt Consolidation Loans: What You Need To Know
What is a debt consolidation loan and how does it work?
A debt consolidation loan is a single loan that you use to pay off multiple debts, such as high interest credit card balances, medical bills, or other unsecured debt. This strategy can reduce the total interest you owe on the debt and help you pay it off faster.
Online lenders, some banks, and credit unions offer debt consolidation loans. If you qualify, the lender deposits the loan into your bank account and you use that money to pay off your debts. Some lenders will send your loan proceeds directly to your creditors, saving you this step.
Once you have paid off your other debts, you make monthly payments for the debt consolidation loan. Payments are fixed for the life of the loan, typically two to seven years.
Debt consolidation is one of the strategies of pay off the debt. Debt consolidation won’t work if you have too much debt or haven’t addressed the underlying spending issues.
How Do I Qualify For A Debt Consolidation Loan?
Almost all lenders require that you be 18 years of age or older, a legal resident of the United States with a verifiable bank account and not in bankruptcy or foreclosure.
Borrowers with good or excellent credit (690 or more on the FICO scale) and poor debt / income ratios may qualify for lower interest rates. Strong credit can also qualify you for larger loan amounts.
Someone with bad or fair credit (689 or less on the FICO scale) and a stable income may still qualify, but would likely see a higher interest rate. It may be worthwhile to shop around and compare the rates of debt consolidation loans to find the most affordable.
What rate should I expect?
Debt consolidation loans work best if the loan has a lower interest rate than the combined interest of your existing debts. You can use NerdWallet debt consolidation calculator to see your total balance, total monthly payment, and your combined debt interest rate.
Rates vary from lender to lender and are highly dependent on your credit history and ability to repay. Here is what interest rate on personal loans looks on average like:
25.3% (lower scores are unlikely to qualify).
Source: Average rates are based on aggregated, anonymized offer data from users who prequalified in the NerdWallet lender market from July 1, 2020 through July 31, 2021. Rates are estimates only and are not intended for use. specific to any lender.
How Will Debt Consolidation Affect My Credit Rating?
Lenders will do a credit check when you apply for a debt consolidation loan. This temporarily lowers your credit score by a few points and will stay on your credit report for two years.
Like other forms of credit, making your monthly loan payment on time and in full helps you build credit, while missing payments could damage it.
If you took out the loan to pay off credit card debt but end up having a balance on your cards while the loan is still active, your credit score could suffer.
As long as you are able to pay off your loan and stay out of debt, consolidation could have an overall positive effect on your credit.
Debt Consolidation vs Balance Transfer Card
For borrowers with good credit, a credit card balance transfer is an alternative to debt consolidation loan. These cards have an introductory interest rate of 0%, which increases after a promotional period, typically no longer than 18 months.
You will want to pay off the card balance before the introductory period expires, as your card’s regular interest rate will then go into effect. In addition to paying off your balance before the rate increases, you’ll want to avoid charging other fees.
Unlike balance transfer cards, borrowers of all credit categories may be eligible for a personal loan, although rates vary. Fixed payments on a personal loan also ensure that you will pay off your debts on a set schedule. And while a card issuer will decide your credit limit on a balance transfer card, personal loan borrowing limits are generally high, with some lenders offering loans of $ 50,000 or more.
A personal loan balance is reported as installment debt, which is treated differently in credit scoring formulas than revolving debt such as credit cards. Revolving debt has a bigger impact on your score, so paying off a balance transfer card could help you build credit faster.
How to choose a debt consolidation loan
Choosing the right debt consolidation loan will depend on your credit score, income, desired loan amount, and repayment term, but it’s a good rule of thumb to look for the lowest. annual percentage rate.
Many online lenders will allow you prequalified to compare rates, which will not hurt your credit score. This feature is less common among banks and credit unions.
You should also look for lenders who specialize in debt consolidation or offer benefits such as sending your loan funds directly to your creditors, reporting payments to the three major credit bureaus, and providing financial education. free.
NerdWallet has reviewed over 30 lenders to help you choose the right one for you. Below is a list of lenders that stand out debt consolidation loans.
How to manage my debt consolidation loan
As you progress through your loan repayment, keep your credit card balance at zero until you are debt free. But try not to close your accounts, which can lower your credit score. Some creditors may require you to pay a fee to keep your account open.