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Debt Consolidation Loans: What You Need to Know
February 5, 2021
What is a debt consolidation loan and how does it work?
A debt consolidation loan is a single loan you use to pay off multiple debts, such as balances on high-interest credit cards, medical bills or other unsecured debt. This strategy can lower the total interest you owe on the debt and help you pay it off faster.
Online lenders, some banks and credit unions offer debt consolidation loans. If you qualify, the lender deposits the loan into your bank account, and you use that money to pay off your debts. Some lenders will send your loan proceeds directly to your creditors, saving you that step.
Once you pay off your other debts, you make monthly payments toward the debt consolidation loan. Payments are fixed for the life of the loan, typically two to seven years.
Debt consolidation is one of several strategies for paying off debt. Debt consolidation won’t work if you have too much debt or haven’t fixed underlying spending issues.
How do I qualify for a debt consolidation loan?
Almost all lenders require you to be 18 years or older, a legal U.S. resident with a verifiable bank account and not in bankruptcy or foreclosure.
Borrowers with good or excellent credit (690 or higher on the FICO scale) and low debt-to-income ratios may qualify for lower interest rates. Strong credit may also qualify you for larger loan amounts.
Someone with bad or fair credit (689 or lower on the FICO scale) and steady income may still be able to qualify, but would likely see a higher interest rate. It can pay to shop around and compare rates on debt consolidation loans to find the most affordable one.
What rate should I expect?
Debt consolidation loans work best if the loan has a lower interest rate than the combined interest on your existing debts. You can use NerdWallet’s debt consolidation calculator to see your total balance, total monthly payment and combined interest rate across your debts.
Rates vary from lender to lender and depend heavily on your credit history and ability to repay. Here is what interest rates on personal loans look like, on average:
How's your credit?
28.7% (Lowest scores unlikely to qualify.)
Source: Average rates are based on aggregate, anonymized offer data from users who pre-qualified in NerdWallet’s lender marketplace between Jan. 1, 2020, and Dec. 31, 2020. Rates are estimates only and not specific to any lender.
How will debt consolidation affect my credit score?
Lenders will conduct a hard credit inquiry when you apply for a debt consolidation loan. This temporarily lowers your credit score by a few points and will stay on your credit report for two years.
Like other forms of credit, making your loan’s monthly payment on time and in full helps you build credit, while missing payments could damage it.
If you took out the loan to pay off credit card debt but end up carrying a balance on your cards while the loan is still active, your credit score could suffer.
As long as you are able to pay off your loan and stay out of debt, consolidation could have a positive overall effect on your credit.
Debt consolidation vs. balance transfer card
For borrowers with good credit, a balance transfer credit card is an alternative to a debt consolidation loan. Such cards have an introductory 0% interest rate, which increases after a promotional period, usually no more than 18 months.
You’ll want to pay the card’s balance before the introductory period expires, because then your card’s regular interest rate will kick in. In addition to paying off your balance before the rate increases, you’ll want to avoid making further charges.
A personal loan offers some advantages over balance transfer cards.
Unlike balance transfer cards, borrowers across the credit spectrum may be able to qualify for a personal loan, though rates will vary. Fixed payments on a personal loan also ensure you’ll pay off debt on a set schedule. And while a card issuer will decide your credit limit on a balance transfer card, personal loan borrowing limits are typically high, with some lenders offering loans of $50,000 or more.
A personal loan balance is reported as installment debt, which is treated differently in credit scoring formulas than revolving debt such as credit cards. Revolving debt has a larger impact on your score, so paying off a balance transfer card could help you build credit faster.
How to manage my debt consolidation loan
Creating a budget that accounts for your loan payments is an important step toward successful consolidation. NerdWallet recommends the 50/30/20 rule, which divides your income into three categories: needs, wants, and savings and debt repayment.
As you make progress on paying off your loan, keep your credit card balances at zero until you are debt-free. But try not to close your accounts, which can lower your credit score. Some creditors may require you to pay a fee to keep your account open.
How to choose a debt consolidation loan
Choosing the right debt consolidation loan will depend on your credit score, income, desired loan amount and repayment term, but it’s a good rule of thumb to look for the lowest annual percentage rate.
Many online lenders will let you pre-qualify to compare rates, which won’t hurt your credit score. This feature is less common among banks and credit unions.
You should also look for lenders that specialize in debt consolidation or offer perks like sending your loan funds directly to your creditors, reporting payments to the three major credit bureaus and offering free financial education.
NerdWallet has reviewed more than 30 lenders to help you choose one that’s right for you. Below is a list of lenders that offer standout debt consolidation loans.
Best for bad credit and fast funding: Upstart.
Best for fair credit and paying off credit card debt: Payoff.
Best for fair credit and direct payment to creditors: Upgrade.
Best for good credit and flexible payment options: Discover.
Best for good credit and no fees: Marcus by Goldman Sachs.
Best for excellent credit and low rates: SoFi.
Annual Percentage Rates (APR), loan term and monthly payments are estimated based on analysis of information provided by you, data provided by lenders, and publicly available information. All loan information is presented without warranty, and the estimated APR and other terms are not binding in any way. Lenders provide loans with a range of APRs depending on borrowers' credit and other factors. Keep in mind that only borrowers with excellent credit will qualify for the lowest rate available. Your actual APR will depend on factors like credit score, requested loan amount, loan term, and credit history. All loans are subject to credit review and approval.