What Is a Debt Consolidation Loan? - NerdWallet (2024)

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A debt consolidation loan is a type of personal loan that you use to combine your existing debts into a single debt with one monthly payment.

Using a debt consolidation loan can reduce the total interest you owe and help you pay down debt faster. It can also simplify the payoff process, as you only have one monthly payment to account for in your budget.

Borrowers often use these loans to pay off high-interest credit cards, though you can use them to tackle other debt, like medical bills and payday loans.

The availability and interest rates of debt consolidation loans largely depend on your credit score: The better your score, the more options you have and the lower interest you’ll likely pay.

» MORE: Best debt consolidation loans

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How do debt consolidation loans work?

Debt consolidation loans work by paying off your current debts with a lump sum. Loan amounts usually range from $1,000 to $50,000 with repayment terms from two to seven years.

Let’s say you have four credit cards, each with a $5,000 balance. Instead of making monthly payments on each credit card, you take out a debt consolidation loan for $20,000 and use that money to pay off your credit cards. You’re then left with one monthly payment on your new loan.

Pros and cons of debt consolidation loans

Pros

Low rates: Debt consolidation loans can be a lifeline for those sinking in high-interest debt, since they typically offer lower interest rates than most credit cards, depending on your credit score. For example, the average interest rate for credit cards for the second quarter of 2023 was 22.16%, while the average interest rate for a two-year personal loan was 11.48%, according to the Federal Reserve.

Streamlined debt payoff: You can save money on interest, and you can apply those savings to your loan to clear th debt even faster. Consolidated debt may also be easier to manage, since you’re only keeping track of a single, fixed monthly payment.

Cons

Potentially high bar to qualify: Borrowers with bad credit (629 credit score or lower) may not qualify for an interest rate lower than the ones on their current debts.

Penalties for missed payments: If you fall behind on payments, you may be charged a late fee, and the missed payment may be reported to the credit bureaus, further hurting your credit score.

» MORE: Debt consolidation loan rates

Are debt consolidation loans a good idea?

A debt consolidation loan is usually a good idea if you can get one with a lower annual percentage rate than the rates on your existing debts and you’re able to make the monthly payments.

Plug your existing debts and credit score into NerdWallet’s debt consolidation calculator to see your consolidation options and calculate your potential savings with a debt consolidation loan.

Debt consolidation also works best if you've already kicked any spending habits. If you keep swiping your credit cards after you've consolidated and freed them up, your credit and finances could suffer.

What Is a Debt Consolidation Loan? - NerdWallet (7)

Do debt consolidation loans hurt your credit score?

Like most forms of credit, a debt consolidation loan will impact your credit score when you apply and as you pay it off.

When you apply for a debt consolidation loan, lenders usually require a hard pull of your credit report, which can temporarily knock down your credit score a few points. And if you use the loans to pay off credit card debt but end up carrying large balances on those cards again while you pay off the loan, your utilization will rise and your score may suffer.

However, taking the loan and a short-term credit score dip might make sense if the loan gives you more manageable payments that you can make on time each month. Payment history accounts for over one-third of your credit score.

Using a debt consolidation loan to pay off revolving debt, like credit cards, can bring your credit utilization down, which may also improve your score.

How to qualify for a debt consolidation loan

Your ability to qualify for a debt consolidation loan depends primarily on your credit score and credit history.

Borrowers with good or excellent credit (690 credit score or higher), little debt and high incomes usually qualify for the lowest rates on debt consolidation loans and have a wider range of lenders to choose from.

Borrowers with bad to fair credit (300 to 689 credit score) are viewed as riskier by lenders and may only qualify for debt consolidation loans from lenders that target bad-credit borrowers.

» COMPARE: Best debt consolidation loans for bad credit

The best way to learn if you qualify for a debt consolidation loan is to go through the steps to pre-qualify. One of the benefits of the pre-qualification process is that it uses a soft credit pull and gives you a sense of the loans and rates available to you without hurting your credit score.

You can pre-qualify for free on NerdWallet and compare loans from online lenders.

How to get a debt consolidation loan

Make a list of all of your debts and monthly payments that you want to consolidate. Any debt consolidation loan you take on should be large enough to cover these debts, and the loan’s interest rate and monthly payment amount should be lower than what you’re currently paying.

Make sure the loan payment fits within your budget. A debt consolidation loan won’t be helpful if it ends up putting you further into debt.

Know your credit score and the loan amount and interest rate you want, then shop around and compare loans available to you. Check online lenders, ​credit unions and banks, each of which offer different benefits.

» MORE: 5 steps to get a debt consolidation loan

Other ways to consolidate your debt

Debt consolidation usually involves getting a loan, but other options include refinancing with a 0% interest balance transfer credit card, tapping into your home’s equity or using your 401(k) savings.

Zero-interest credit card: Refinancing your debt with a 0% interest balance transfer card can be useful for smaller debts that you can pay off during the card’s no-interest promotional period, which usually lasts 15 to 21 months. You’ll likely need good or excellent credit to qualify.

» MORE: How do 0% APR credit cards work?

Home equity financing: If you own a house, you could also borrow against your home's equity to pay off your debts. Home equity loans and home equity lines of credit may have low interest rates, but if you stop making payments, you could lose your home.

» MORE: Should you use home equity to pay off debt?

401(k) loan: Some people choose to take a loan from their employer-sponsored retirement account, known as a 401(k) loan. These loans usually have low interest rates, but borrowing from your 401(k) means you’ll miss out on the potential to grow your retirement savings.

» MORE: 5 ways to consolidate credit card debt

A debt consolidation loan is a type of personal loan that allows you to combine your existing debts into a single debt with one monthly payment. This can help simplify the payoff process and potentially reduce the total interest you owe, allowing you to pay down your debt faster. Debt consolidation loans are often used to pay off high-interest credit cards, but they can also be used for other types of debt, such as medical bills and payday loans.

The availability and interest rates of debt consolidation loans largely depend on your credit score. Generally, the better your credit score, the more options you have and the lower interest rate you are likely to pay. It's important to note that borrowers with bad credit may not qualify for an interest rate lower than the ones on their current debts.

Debt consolidation loans work by paying off your current debts with a lump sum. Let's say you have multiple credit cards with different balances. Instead of making separate monthly payments on each credit card, you can take out a debt consolidation loan for the total amount and use that money to pay off your credit cards. This leaves you with one monthly payment on your new loan.

There are pros and cons to consider when it comes to debt consolidation loans. Some advantages include potentially lower interest rates compared to credit cards, streamlined debt payoff, and the ability to save money on interest. However, there are also potential downsides, such as a potentially high bar to qualify for lower interest rates, penalties for missed payments, and the risk of falling further into debt if spending habits are not addressed.

Whether a debt consolidation loan is a good idea depends on your individual circumstances. It can be beneficial if you can secure a loan with a lower interest rate than your existing debts and if you are able to make the monthly payments. It's important to consider your credit score, the loan amount, and interest rate you want, and to shop around and compare loans from different lenders.

Taking out a debt consolidation loan may impact your credit score. When you apply for the loan, lenders usually require a hard pull of your credit report, which can temporarily lower your credit score. Additionally, if you use the loan to pay off credit card debt but continue to carry large balances on those cards, your credit utilization may rise and your score may suffer. However, using a debt consolidation loan to pay off revolving debt like credit cards can also bring down your credit utilization, which may improve your score.

To qualify for a debt consolidation loan, your credit score and credit history play a significant role. Borrowers with good or excellent credit, little debt, and high incomes usually qualify for the lowest rates on debt consolidation loans. On the other hand, borrowers with bad to fair credit may be viewed as riskier by lenders and may only qualify for loans from lenders that target bad-credit borrowers .

To get a debt consolidation loan, you should make a list of all your debts and monthly payments that you want to consolidate. The loan amount should be large enough to cover these debts, and the loan's interest rate and monthly payment amount should be lower than what you're currently paying. It's important to ensure that the loan payment fits within your budget and won't put you further into debt. You can compare loans from online lenders, credit unions, and banks to find the best option for you.

In addition to debt consolidation loans, there are other ways to consolidate your debt. These include refinancing with a 0% interest balance transfer credit card, tapping into your home's equity through home equity financing, or taking a loan from your employer-sponsored retirement account (401(k) loan). Each option has its own benefits and considerations, so it's important to evaluate them based on your specific situation.

In conclusion, a debt consolidation loan can be a useful tool for simplifying debt repayment and potentially reducing interest rates. However, it's important to carefully consider your credit score, loan terms, and budget before deciding if it's the right option for you.

What Is a Debt Consolidation Loan? - NerdWallet (2024)
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