How to get a debt consolidation loan

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Man pushing a big ball labeled “DEBT” on a steep hill

If you have multiple debt balances from credit cards, high interest loans, and other forms of debt, you may want to merge them into one payment. You can use a debt consolidation loan to combine them into one low interest loan. There are many options out there, so it’s important to understand what a debt consolidation loan is and how to find the right one for you.

Debt consolidation loans, defined

A debt consolidation loan is a loan that you use to pay off your other debt balances. This allows you to make just one payment each month, usually at a much lower interest rate than your other debt balances. By consolidating your debt payments into one, you eliminate the risk of forgetting payments and can generally pay less over the life of your loan due to the lower interest rates.

Eligibility for a Debt Consolidation Loan

To qualify for a debt consolidation loan, you will usually need to present:

  • Proof of income. This is one of the most important factors in getting approved for a debt consolidation loan because it shows whether you can actually afford the monthly payments.

  • Credit history. Your credit history shows a lender that you have made consistent payments in the past so the lender can be reasonably certain that you will continue this trend.

  • Financial stability. Lenders want to know that you are not a high risk borrower. Depending on how much debt you are consolidating and what the debt is for, they may ask for collateral such as home equity. This is more common for larger loans.

Apply for a debt consolidation loan

Debt Consolidation Loan Application

Debt Consolidation Loan Application

Once you have decided that a debt consolidation loan is the best way for you to manage your debt, you will need to apply for a personal loan. If you have poor or average credit, you may still be able to get a personal loan. These loans often come with high interest rates, so make sure that while shopping you are making sure that a consolidation loan will either help you lower your monthly payment or lower your overall interest rate. Here are some steps you can take to get a debt consolidation loan.

Check your credit score

The first step in getting a personal debt consolidation loan is knowing your credit score. If you have a good credit rating, you will get better rates and terms on your loan. If your credit score is low, you may want to take a few months to work on increasing your score in order to qualify for better terms.

List your debts

Next, make a list of all the revolving debt balances that you want to consolidate. You must indicate the principal balance, the interest rate and the monthly payment. This will help you understand how much you are paying each month, the total you will pay if you don’t consolidate, and how much you will need to take out to consolidate all of those loans.

Compare options

Now that you know how much you will need to purchase, you can compare the options available. You can shop around with lenders online and check with local banks and credit unions for interest rates and terms you may be eligible for. Some lenders may allow you to pre-qualify to see the terms and rates you will qualify for without doing a serious credit investigation, which can impact your credit score.

Apply for a loan

Finally, you will apply for the loan that best suits your needs. Make sure you understand the details of the loan by reading the fine print and asking all relevant questions of your lender. Once you have applied for the loan and have been approved, you will sign the documents to complete the loan. Now you will only have one monthly payment to make. This payment may be less than what you had paid on your debts each month before.

Debt Consolidation Loans: Benefits

If you have multiple debt payments to make each month, a debt consolidation loan might be the best option for you. Here are some of the benefits of using a personal loan for debt consolidation:

  • A monthly payment. When you streamline your payment process, you no longer have to deal with multiple deadlines or risk forgetting to pay an invoice. Plus, your payment will be the same every month, so you know exactly how much to budget for that loan repayment.

  • Improve your credit. When you make regular payments on time, your credit score goes up. Additionally, if you stop using credit cards that once carried a balance, your credit usage will decrease, thereby increasing your credit score.

  • Pay off debt sooner. The interest rates on some credit cards and other high interest loans can be so high that you never pay off your balance. With a debt consolidation loan, you will be able to pay off your debt within a specified period of time.

  • Lower monthly payments. When you consolidate your debt, maybe you consolidate one that has one year to pay off and one that has five years to pay off. When you consolidate your total balance, it can end up spreading out those payments, lowering the amount you are supposed to pay each month.

  • Less interest. If you consolidate your high interest debt with a personal loan, chances are you have a lower overall interest rate. This can save you a lot of money over the life of your loan.

Debt Consolidation Loans: Cons

Of course, debt consolidation is not for everyone. Here are a few things to watch out for:

  • Federal loan cancellation. If you consolidate your federal student loans, you risk losing many of the benefits of federal student loans, including the cancellation of federal loans.

  • The initial costs. You can pay origination fees, balance transfer fees, closing costs, annual fees, and more on a personal loan. Make sure you read the fine print of your loan terms before taking out a personal loan to understand the fee structure.

  • Spending spending habits. If you are paying off your credit card balance with a personal loan but are used to accumulating credit card debt, a personal loan could put you in more debt. Make sure you’re using a personal loan to your advantage, not to justify your spending habits.

Alternatives to debt consolidation loans

While getting a debt consolidation loan can help you save money on interest and make the repayment much more manageable, it’s not always the best solution. Here are a few other options you may want to consider:

Create a budget

You may want to create a monthly budget that includes paying off larger debts. This can help you reduce the principal amount of your loans at the highest interest rate, thus lowering the amount you will also owe in interest.

Debt management plan

A debt management plan is a program offered by debt management companies to help you lower your monthly payments and the interest rates on your debt. They can also help you reduce or waive penalties. If you’ve struggled to make payments in the past, debt management plans can help you stay on top of your finances while reducing your unsecured debt.

Refinance higher interest loans

If you want to pay off your loan faster, you may be able to refinance your higher interest loans with a balance transfer credit card or other refinancing option. It may require additional fees, but if you can negotiate a lower interest rate or monthly payments, it may be a viable option.

Bankruptcy

If the bills keep piling up and you feel completely overwhelmed by your debt load, you may want to consider filing for bankruptcy for some relief. Bankruptcy is a legal process that frees debtors from their debts. However, debtors might not be able to qualify for future debts such as mortgages, credit cards, etc. Filing for bankruptcy should be an absolute last resort because it will stay on your credit report for seven to 10 years and may impact your ability to qualify for loans in the future.

The bottom line

Dart hits the nail on the head with a labeled board "DEBT WITHOUT"

Dart hits the nail on the head of a board labeled “DETTE SANS”

If you have multiple debts and are having trouble managing them, debt consolidation can be a good way to help organize your finances. The terms of these types of loans normally range from two to five years. Borrowers with good debt-to-income ratios are more likely to get favorable interest rates. While unsecured debt consolidation loans can be beneficial for some, they come with risks such as allowing people to maintain excessive spending habits. Make sure to check out the balance transfer credit card options.

Tips for Managing Credit Card Debt

  • A financial advisor can help you budget that matches your income and debt. Finding a financial advisor doesn’t have to be difficult. SmartAsset’s free financial advisor tool can quickly connect you with up to three local financial advisers that match your needs. If you are ready, start now.

  • Beware of debt settlement companies, many of which have earned a reputation as predatory traders. They promise to consolidate debt into one easy payment, but there are often fees built into the monthly payment. Sometimes they even hold the money to earn interest before making payment to your creditors, resulting in additional late fees for you.

Photo credit: © iStock.com / NiseriN, © iStock.com / designer491, © iStock.com / AndreyPopov

The article How to Get a Debt Consolidation Loan first appeared on the SmartAsset blog.


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