What Is a Debt Consolidation Loan?

Debt consolidation loans are used to consolidate (or combine) multiple balances into one loan. A debt consolidation loan can merge credit card balances, medical bills, personal loans, and other types of debt to potentially help save you both time and money. Getting approved for a debt consolidation loan typically hinges on factors like your credit score and income. 

Here’s everything you need to know about these loans and how to get them.

Debt Consolidation Loan Explained 

A debt consolidation loan is a consumer installment loan with a singular purpose: combining your existing debts. When you get a debt consolidation loan, you typically borrow a lump sum of money which is then used to pay off creditors for other loans and outstanding balances. Moving forward, you’ll then make payments to your debt consolidation lender instead of the previous creditors.

Consolidating could give you a lower monthly payment, reduced interest rate on your debt, or both. It could also make it easier to pay off the consolidated debts as you only have one monthly payment and one due date to track.

A debt consolidation loan can be secured or unsecured and can involve both interest and fees. The interest rates, fees, and repayment terms for your debt consolidation loan depend on the type of loan you choose and even your specific lender. 

What Kinds of Debts Can You Consolidate?

The types of debt you can combine with loan consolidation include:

• Credit cards

• Medical bills

• Unsecured personal loans

• Auto loans (depending on the lender)

Most consumers consolidate unsecured debt, which doesn’t hold a physical asset (like a car or house) as collateral. However, you might consider consolidating any eligible debt with less favorable terms than the debt consolidation loan would have. For instance, if your consolidation loan interest rate is lower than your credit cards’ APRs but higher than your auto loan’s APR, you might consolidate the credit card accounts but not the car loan. 

Types of Debt Consolidation Loans

There are several types of debt consolidation loans to consider. Some of the most common include:

• Home equity loan:This secured loan allows you to borrow against your home’s available equity. Home equity loans typically offer a lump sum with a fixed interest rate, paid back over a period of five to 30 years. 

• Home equity line of credit (HELOC): Home equity lines of credit (HELOCs) are another way to borrow against your equity. This is a revolving line of credit that allows you to borrow, repay, and borrow again as often as you like, up to your loan limit. You can do this during the first few years, called the draw period. Then you enter the repayment period and can’t borrow more. HELOCs typically have a variable interest rate.

• Cash-out refinance loan: By refinancing your mortgage, it’s possible to borrow more than enough to pay off your current mortgage. You get the difference in the form of cash you can spend. The money can then be used to consolidate debt, fund large purchases, renovate your property, or cover another large expense. Rates can be fixed or variable with a range of repayment terms.

Home equity loans, HELOCs, and cash-out refinance loans are mortgages. If you don’t repay the loan, you could lose your home. Other types of debt consolidation loans include:

• Personal loan: A common option for debt consolidation is an unsecured personal loan. These lump sum loans are typically for $1,000 to $100,000, depending on the lender and your creditworthiness. They have a set repayment period and fixed interest rate.

• Balance transfer credit card: You could use a credit card balance transfer to pay off existing debt (including other credit cards). This essentially moves your balance(s) from one creditor to another and generally involves a balance transfer fee. Many people do this because the new card offers a 0% or very low interest rate for a period of time. 

What Is the Best Debt Consolidation Loan?

The best debt consolidation loan is the one that helps you reach your financial goals.  

It’s important to make sure your new loan has a lower interest rate than the debt you want to consolidate. But other than that, the benefits depend on your goals.  A debt consolidation loan could help you:

• Simplify and streamline the debt repayment process

• Lower your interest rate

• Lower your monthly payment

• Lower the total amount of interest you pay

• Get a set payoff date for your debt

• Get rid of your debt faster than by making minimum payments on credit cards

You don’t have to get all of these benefits to make debt consolidation a worthwhile strategy.

Home equity loans and HELOCs could be better for borrowing large amounts, if you have enough equity in your home. 

A cash-out refinance could let you borrow against your home without adding a new loan payment (a home equity loan is a second mortgage so you’ll have two payments if you’re still paying off your home).

Personal loans for debt consolidation may be a good option if you have a good credit score and need to borrow less than $100,000. You could still get personal loans for debt consolidation with bad credit but may pay a higher interest rate, so it's important to consider whether this option could save you any money.  

Balance transfer credit cards could help you consolidate debt at a low (or even 0%) APR. However, there’s almost always a fee for each balance transfer, and the promotional APRs expire. 

How Do I Get a Debt Consolidation Loan?

If you own a home and are considering a home equity loan, HELOC, or cash-out refinance, you might talk to your current mortgage lender first. Your lender can tell you what you qualify to borrow and estimate your interest rate.

If you're looking for a personal debt consolidation loan, speak with a few personal lenders or start your search at an online marketplace where you can compare rates and terms from different lenders at once. If a loan option appeals to you, you can then take the next step and apply. 

Evaluate multiple loans before choosing so you can be sure you’re taking the best offer. When comparing debt consolidation loan options, pay attention to:

• Interest rates

• Fees (including origination fees and prepayment penalties)

• Closing costs

• Loan repayment terms

With credit card balance transfer offers, look at the APR you'll pay, how long that rate will last (if introductory), and any balance transfer fees. If you're considering a card that offers a 0% APR transfer for 18 months, it helps to think about whether that's enough time to pay off the balance before the regular interest rate kicks in. 

What If I Can’t Find What I Need?

If you've looked at each of these debt consolidation loan options and can't find a suitable solution, there are other possibilities for managing debt. For example, you could seek debt relief through debt settlement or a debt management plan (DMP). 

With a debt management plan, you make one monthly payment to a credit counselor, which is then distributed among your creditors until your balances are paid off. You’ll pay off your debts in full in three to five years, but a debt management plan could save you money if your credit counselor negotiates a lower interest rate or fee waivers on your behalf.  

Debt settlement is negotiating with your creditors to clear your debts for less than you owe. You can try to settle debts alone, but it may be helpful to collaborate with an experienced debt settlement company that can work with your creditors to reach an agreement.