A guide to using a personal loan for debt consolidation

Credit can help you pay for essential expenses in life. Student loans help you pay for college, auto loans help you afford a car, and credit cards offer a way to spread out your expenses over time. However, handling multiple accounts, each with its own interest rate and due date, can be challenging. Consolidating your debts with a personal loan is one way to simplify your finances and save money on interest.

Key takeaways:

• A debt consolidation loan offers the potential to save on interest rates and simplify debt repayment.
• Lenders may charge fees for debt consolidation, and taking out a loan could have an impact on your credit score.
• Checking your credit, creating a budget, and making plans to avoid accumulating more debt are essential for effectively leveraging a personal loan.

What is a personal loan?

A personal loan allows you to borrow a lump sum of money and repay it with interest over a specific period. Loan terms vary by lender but usually are 36 – 60 months.

Lenders will review your credit history, credit score, income, and debt-to-income ratio when evaluating your application.

Personal loans usually allow you to borrow any amount up to $50,000. You often need to pay an origination fee of 1% – 10% of the loan amount.

They usually have a fixed interest rate, so your payments are predictable. Expect your annual percentage rate, or APR, to range from roughly 8% – 36%.

Personal loans are usually unsecured, which means no collateral is required. A secured personal loan often will come with a lower interest rate.

How to consolidate debt with a personal loan

To consolidate debt, you’d take out a personal loan for enough money to pay off your other debts. You then would have only one monthly payment to make. If the interest rate on your personal loan is lower than the rate on your previous debts, you’ll also save money on interest. You also will have a set term for paying off the personal loan and retiring those debts in full.

Preparing to apply for a personal loan for debt consolidation

Having a clear plan on what debts you want to consolidate is key.

Compare loan types

Start by adding up the debts you want to consolidate and see which type of personal loan will allow you to borrow enough to pay them off. Don’t forget to consider your ideal repayment term and whether you want a secured or unsecured loan.

Check your credit score

Checking your credit score gives you the opportunity to understand the types of lenders who are more likely to work with you. Aside from lenders, certain types of loans may require you to meet their minimum credit score requirements.

Understand interest rates and terms

Understanding what interest rates and fees you may pay when comparing different personal loan options will help you see which loan may cost you the least. Lenders also offer different repayment terms. The longer the repayment period, the more interest you will need to pay back over the life of the loan.

Shop around

Obtaining quotes from multiple lenders will enable you to compare loans and find the best rate and term that suits your needs. Loan prequalification provides an estimate of how much your lender expects you to qualify to borrow.

Choose a loan and apply

To help the application process go as smoothly as possible, check with the lender beforehand what documentation you need to provide.

Most lenders let you apply online and fund your loan quickly once you’re approved.

Benefits of debt consolidation loans

Consolidating your debts with a personal loan has many benefits.

Simplified payments

By rolling all or some of your current debts into one loan, you no longer need to juggle multiple payments and due dates.

Potential interest savings

Compared with your current debts, personal loans may offer lower interest rates. If so, you may be able to save on interest charges.

It can help you be debt-free

If you avoid taking on additional loans or carrying a credit card balance, you can be debt-free when you finish paying off your personal loan.

A higher credit score

Taking out a personal loan can boost your credit score if you consistently make on-time payments. If you’re using the loan to consolidate credit card balances, for example, you could improve your score if this move results in a lower credit utilization ratio.

Potential risks of debt consolidation

Consolidating debts with a personal loan also has its drawbacks.

Risk of accumulating more debt

Yes, a debt consolidation loan can simplify monthly loan payments. But if you continue to use your credit cards, you risk accumulating more debt than you can reasonably handle.

Fees and costs associated with consolidation

Most loans come with additional costs, such as origination or balance transfer fees. Consider these fees when deciding if a personal loan for debt consolidation is worthwhile.

How to leverage personal loans for a debt-free future

Here are some best practices for using a personal loan to consolidate and pay off your debts.

Create a budget

Once you know the monthly payment on your debt consolidation loan, allocate a space in your budget for it. It’s the perfect time to create a spending plan for your other expenses so you don’t risk overspending.

Make on-time monthly payments

Your payment history is one of the most significant factors in determining your credit score. On-time payments show that you are committed to being a responsible borrower. Paying your loan on time also means you’ll avoid late fees and additional charges.

Alternatives to personal loans for debt consolidation

If a personal loan doesn’t work for you, here are some other debt consolidation options to consider.

Home equity loans

Home equity loans let you borrow a lump sum of money using your home equity as collateral. You need to own a home with equity to qualify for one, but home equity loans typically have much lower interest rates than personal loans or credit cards.

HELOCs

A home equity line of credit, or HELOC, is a revolving line of credit based on your home equity. You can borrow from your HELOC as needed during the draw period and make minimum payments on the amount borrowed. Once the draw period is over, you’ll no longer be able to borrow from the HELOC. You then make payments on the principal and interest until the debt is retired.

Credit card balance transfer

Many credit card companies entice you to consolidate debt by transferring your balances to a new card with an introductory interest rate that’s as low as zero percent. Once the introductory rate expires, you’ll pay the card’s normal interest rate. If you can repay your debt before the introductory rate expires, you can save a lot of money. Before making a transfer, check if there are any balance transfer fees, when the introductory rate ends, and what happens if you miss a payment.

Peer-to-peer loans

Also known as P2P loans, borrowers apply for peer-to-peer loans directly from individual lenders instead of going through a bank or financial institution. You can apply for these loans through an online marketplace, where both lenders and borrowers are vetted. Once you go through an initial application process, you’ll be able to see what rates and terms you qualify for. A lender can view your application and decide whether to fund your loan. Since you’re not going through a more traditional loan process, you may be able to better qualify for a P2P loan even if your credit isn’t as stellar.

The bottom line: Consolidate debts with a personal loan

Using a personal loan for debt consolidation offers the potential for lower monthly payments, saving on interest, and simplifying your payment strategy. To reap the benefits, you’ll need to make on-time payments and avoid falling back into debt. Taking steps like creating a realistic budget and consistently sticking to it will help your dream of becoming debt-free in the future become a reality.

Interested in a debt consolidation loan? Start your personal loan application today with Rocket Loans℠.