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A debt consolidation loan is a loan 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 on the debt and help you pay it off faster. It can also make paying down debt simpler, as you only have one monthly payment to account for in your budget.
The availability and interest rates of debt consolidation loans largely depend on your individual credit score: The better your score, the more options you have and the lower interest you’ll pay.
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 of two to seven years.
For example, 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
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 third quarter of 2022 was 18.43%, while the average interest rate for a two-year personal loan for the same time period was 10.16%, according to the Federal Reserve.
You can save money on interest, and you can also apply that savings to your loan, helping you get out of debt even faster. Consolidated debt may also be easier to manage, since you’re only keeping track of a single, fixed monthly payment.
But debt consolidation isn’t without its cons. Borrowers with bad credit (629 credit score or lower) may not qualify for an interest rate lower than the ones on their current debts. If you qualify, you must still keep up with a monthly payment. If you fall behind, you may be charged a late fee, and the missed payment may be reported to the credit bureaus, further hurting your credit score.
Consolidating also won’t solve habitual overspending. It can even make it worse since your credit cards will be freed up again.
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 combined rate on your existing debts and make the monthly payments.
You can use NerdWallet’s debt consolidation calculator to plug in your existing debts and credit score to see your consolidation options. You can also calculate your potential savings with a debt consolidation loan.
Do debt consolidation loans hurt your credit score?
Like most forms of credit, a debt consolidation loan will have an impact on 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 credit score will suffer.
However, if the loan puts you in a better situation by enabling more manageable payments that you can make on time each month — which accounts for over one-third of your credit score — then taking the loan and a short-term credit score dip might make sense in the long run.
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.
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.
Refinancing your debt with a 0% interest balance transfer card can be useful for smaller debts that you think 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.
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 lower interest rates, but if you stop making payments, you could lose your home.
Some people choose to take a loan from their employer-sponsored retirement account, known as a 401(k) loan. This option usually gives you access to lower interest rates, but it also cuts into your retirement funds.