What Is a Debt Consolidation Loan?

A debt consolidation loan combines multiple existing debts into a single new loan. You borrow one amount of money and use it to pay off your credit cards, medical bills, or other balances. From that point on, you make one monthly payment to your debt consolidation lender instead of separate payments to each of your original creditors. The right loan could lower your monthly payment, reduce your interest rate, or both, depending on your credit profile.

How Does a Debt Consolidation Loan Work?

You complete debt consolidation in three general steps:

1. Apply for a loan in an amount that covers your current balances.

2. Use the loan money to pay off your existing creditors.

3. Make one monthly payment to your new lender until you pay off the loan.

A debt consolidation loan may be secured or unsecured, and it may involve interest and fees. The interest rate, fees, and repayment terms depend on the type of loan you choose and your lender. A lower rate on the new loan is often what makes consolidation worthwhile. Without one, combining your debts may not save you money.

What Kinds of Debts Can You Consolidate?

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

• Credit cards

• Medical bills

• Unsecured personal loans

• Auto loans (depending on the lender)

Most consumers consolidate unsecured debt, which isn't backed by a physical asset like a car or house. You might consider consolidating any eligible debt with less favorable terms than your new loan would offer. 

For example, say your consolidation loan's interest rate falls between your credit cards' APR and your auto loan's APR. In that case, you might consolidate the credit card accounts and leave the auto loan as is.

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 is a way to borrow against the equity you have in your home. Home equity loans typically provide a one-time payment with a fixed interest rate, repaid over 10 to 30 years.

• Home equity line of credit (HELOC): A HELOC is a line of credit you may use to borrow, repay, and borrow more, as often as you like, up to your loan limit. The draw period, when you borrow, typically lasts 10 years. After that, you enter the repayment period. Repayment periods typically range from 10 to 20 years, depending on your lender and the term you choose. Most HELOCs have a variable interest rate.

• Cash-out refinance loan: A cash-out refinance replaces your mortgage with a new, larger loan and gives you the difference in cash. You could then use the money to consolidate debt, fund large purchases, renovate your property, or cover another large expense. Rates may 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 personal loan is an unsecured loan you can generally use for any purpose. These loans are typically available in amounts from $1,000 to $50,000, depending on the lender and your credit history, though some may go higher. They have a set repayment period and a 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 moves your balance from one creditor to another and generally involves a balance transfer fee. Balance transfer cards often offer a 0% or low introductory interest rate for a limited time only.

Benefits of a Debt Consolidation Loan

A debt consolidation loan may offer several benefits, depending on your goals and the loan you choose:

• Simpler repayment: One monthly payment and due date instead of several.

• A lower interest rate: A new loan with a lower rate than your current debts could reduce how much interest you pay over time.

• A lower monthly payment: A single new loan with different terms could lower your required payment.

• A set payoff date: Unlike a credit card balance, a debt consolidation loan has a fixed end date.

• A faster payoff: Set payments on a debt consolidation loan could get rid of your debt faster than minimum payments on credit cards.

You don't need every benefit on this list for debt consolidation to be worthwhile.

Potential Risks of Debt Consolidation

Debt consolidation carries a few risks to weigh against the benefits:

• A longer payoff period: You risk paying more interest overall and staying in debt longer if your new loan has a longer term than your original debt.

• New debt on old accounts: You risk deeper debt if you pay off credit cards with a personal loan and then add new charges to those cards.

• Unsecured debt becomes secured: A home equity loan turns unsecured debt into secured debt, which isn't eligible for Chapter 7 bankruptcy or debt settlement.

If debt consolidation won't provide enough relief, debt settlement is one alternative to explore. 

Debt settlement may negatively impact your credit.

What Is the Best Debt Consolidation Loan?

The best debt consolidation loan is the one that helps you reach your financial goals. Your new loan should have a lower interest rate than the debt you're consolidating. Beyond that, the right choice depends on your goals.

• Home equity loans and HELOCs could be better for borrowing large amounts if you have enough equity in your home. A home equity loan or HELOC is a second mortgage, so you'll have two payments if you're still paying off your home.

• A cash-out refinance could let you borrow against your home without adding a new loan payment. 

• 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 apply for a personal loan with a lower credit score. The interest rate may be higher in that case, so compare it to your current debt to confirm the loan would still save you money.

• Balance transfer credit cards could help you consolidate debt at a low, or even 0%, APR. Balance transfers generally involve a fee, and the promotional APR expires after a set time.

Are You Eligible for a Debt Consolidation Loan?

Lenders typically review a few factors when you apply for a debt consolidation loan: your credit score, your credit history, and your debt-to-income ratio, which compares your monthly debt payments to your income. Requirements vary by lender and loan type. Secured options, like a home equity loan or HELOC, may have different requirements than an unsecured personal loan.

Many lenders publish minimum credit score requirements for their loans, so compare a few options before you apply.

Debt consolidation tends to make sense when:

• You could realistically repay your debts in full over time.

• A new loan would lower the interest rate on your existing debt.

• You want to streamline your finances and make fewer monthly payments.

How Do I Get a Debt Consolidation Loan?

If you own a home and you're considering a home equity loan, HELOC, or cash-out refinance, start by talking to your current mortgage lender. Your lender may be able to estimate how much you could borrow and what interest rate you might get.

If you're looking for a personal loan for debt consolidation, contact a few lenders or use an online marketplace to compare rates and terms from multiple lenders at once. If an option appeals to you, you could apply.

Compare multiple loan offers before choosing one. Review these factors across debt consolidation loan options:

• Interest rates

• Fees (including origination fees and prepayment penalties)

• Closing costs

• Loan repayment terms

For a balance transfer credit card, review the APR you'll pay, how long that rate lasts if it's introductory, and any balance transfer fees. Confirm you could pay off the balance before the introductory period ends and the regular interest rate applies.

What if a Debt Consolidation Loan Isn't Right for You?

If none of these debt consolidation loan options fit your situation, other ways to manage debt exist. You could explore debt settlement or a debt management plan (DMP).

Debt settlement means negotiating with your creditors to settle your debts for less than you owe. You could try to settle debts on your own. An experienced debt settlement company adds support during creditor negotiations.

Debt settlement may negatively impact your credit.

With a debt management plan, you make one monthly payment to a credit counselor who distributes it among your creditors until your balances are paid off. You'll repay your debts in full within three to five years. A debt management plan could still save you money if your credit counselor negotiates a lower interest rate or fee waivers on your behalf.