Debt Consolidation Loans
- Types of debt consolidation loans include home equity, balance transfer credit cards, and personal loans.
- Personal loans for debt consolidation can help you consolidate debt if you don’t own a home.
- Personal loans for debt consolidation can be secured or unsecured.
Table of Contents
Consolidating debts could bring some financial relief if you're struggling to make payments to multiple creditors. Debt consolidation loans allow you to combine several debts into one and they can potentially reduce the amount of interest you pay. Comparing debt consolidation loan options can help you decide if it's right for you.
How Do Debt Consolidation Loans Work?
Debt consolidation loans work by providing you with a lump sum that you can use to pay off other debts. Assuming you pay off all of your debts with the loan proceeds, you'd just have one payment for the consolidation loan each month.
Debt consolidation loans can charge interest and fees just like any other loan. The rate you pay for a debt consolidation loan can depend on how much you borrow, the loan term and your credit scores. There are debt consolidation loans for people with excellent credit, bad credit and everything in between.
So how can you use debt consolidation loans? Generally, you can use a debt consolidation loan to pay off:
Debt consolidation loans can be secured or unsecured. Some type of collateral backs secured debts. If you fail to pay back the loan, the lender can keep your collateral. Unsecured debts have no collateral requirements.
Who Offers Debt Consolidation Loans?
Different types of lenders can offer debt consolidation loans. If you're talking about general debt consolidation loans that can be used to pay off credit cards, medical bills or other debts, the options usually include:
Local or regional banks
There are also some specialized options for debt consolidation loans. For example, the Department of Education offers debt consolidation for federal student loans. Some lenders help with consolidating IRS tax debt if you cannot get government debt relief via an Installment Agreement or Offer in Compromise.
If you're interested in debt consolidation, it's essential to consider what kind of debts you want to consolidate. Doing so can help you figure out where to look for loans. You can then take the next step and explore different types of debt consolidation loans to decide which option fits your needs.
Types of Debt Consolidation Loans
A debt consolidation loan is generally any loan you use to consolidate debts. But not all debt consolidation loans are precisely the same in terms of how much you can borrow and what you'll pay for the loan.
Generally, debt consolidation loan options include:
Home equity loans
Home equity lines of credit (HELOCs)
Balance transfer credit cards
A home equity loan is a loan against your home's equity. Equity represents the difference between what you owe on the property and what it's worth. Home equity loans offer a lump sum of money you can use to consolidate debts. You then pay back the loan with interest.
Home equity loans are a type of second mortgage since the home secures the loan.
A home equity line of credit (HELOC) also allows you to borrow against your home's equity. The difference is that instead of getting a lump sum, you're getting a line of credit you can draw against as needed. So you only pay interest on the amount of your credit line that you use. The home also secures HELOCs.
Personal loans for debt consolidation are usually unsecured. Depending on the lender, you might be able to borrow anywhere from $5,000 to $100,000. You use the loan proceeds to pay off your debts, then repay the lender with interest.
Balance transfer credit cards aren't loans, per se. Instead, you're opening a new credit card account, ideally at a low or 0% annual percentage rate (APR), then transferring existing balances to that card. You might pay a balance transfer fee to do so and you'll have a set period in which to pay off the balance interest-free before the regular APR kicks in.
Out of these debt consolidation loan options, home equity loans and HELOCs typically offer the lowest interest rates if you need to borrow a larger amount. But you run the risk of losing the home if you default on either one.
Personal loans can be suitable for borrowing medium to large amounts if you don't own a home or you do, but you haven't accumulated much equity yet. Balance transfer cards can be best for small amounts that you can pay off quickly, as the 0% APR won't last forever.
Personal Loans for Debt Consolidation
Personal loans for debt consolidation can increase your payment even if you get a lower interest rate. That's because they're designed so that you’ll repay your debt in a specific term, while credit card minimum payments are designed to keep you in debt forever. But if you're carrying a high APR on your credit cards, personal loans could save you money over time.
Secured personal loans
Secured personal loans let you borrow money to consolidate debt and in exchange, you have to provide the lender with some type of collateral. The collateral that's needed to get a secured personal loan can depend on the lender, but generally, you might be asked to pledge:
Cars or other vehicles you own
Collectibles or antiques
Again, the idea is that if you fail to pay back the loan, the lender can keep your collateral. The lender avoids a total financial loss on the loan since they're getting something of value in the bargain.
Getting a secured personal loan to consolidate debt is something you might consider if you have collateral and pledging it could help you lock in a lower interest rate. Since there's less risk to the lender, they may be willing to cut you a break on rates or fees.
Unsecured personal loans
Unsecured personal loans don't require any sort of collateral, so you don't have to worry about losing your property or assets if you can't pay back what you borrow. However, that could mean a higher interest rate for the loan since the lender's assuming more risk. And defaulting on any loan, secured or unsecured, could hurt your credit scores.
Rates may not be an issue if you have excellent credit since you'd likely qualify for the lowest rates anyway. But if you're trying to get an unsecured personal loan with bad credit, it's important to consider what kind of rates you may be offered. This way, you can decide if an unsecured loan makes sense in terms of how much money you might be able to save on interest.
Whether you're considering a secured or unsecured personal loan, it's crucial to research loan options from different lenders. Specifically, take time to consider:
How much you need to borrow
Loan minimums and maximums
Interest rates and whether you can get a rate discount with autopay
Fees, including prepayment penalties and origination fees
Loan funding speed
Also, look into whether the lender offers direct payment to your creditors. You might be interested in that if you want to avoid any temptation to spend part of the loan proceeds before paying off your debts.
When are debt consolidation loans a good idea?
A debt consolidation loan could be a good idea if combining your debts would allow you to reduce your monthly payments, save on interest or pay your debts off faster. If you have good to excellent credit, you may be able to get approved for a larger loan amount at a lower interest rate. Estimating your loan costs using a debt consolidation loan calculator can help you decide if it's worth it.
What kind of debt can I consolidate with a debt consolidation loan?
Most people consolidate unsecured debt like credit cars because their interest rates tend to be higher. But you can consolidate different types of debt, including credit cards, unsecured personal loans, and medical bills, tax debt, auto loans, business debt, and student loans.
What if I can’t qualify for debt consolidation loans?
If you're unable to qualify for a debt consolidation loan, you may be able to pursue a debt management plan (DMP) or debt settlement instead. A debt management plan allows you to combine your debt payments into one each month while potentially reducing interest rates and eliminating fees. This option might be right for you if you need debt relief and you can commit to an organized plan for paying back what you owe.
Debt settlement allows you to pay back less than what you borrowed from your creditors. You can try to negotiate settlements with your creditors yourself or work with a debt relief company that will negotiate on your behalf. Debt settlement is usually geared toward people who have fallen behind on debt repayment and want to avoid bankruptcy. Talking over the options with a debt relief company can help you decide whether debt management or debt settlement makes sense for you.