Debt consolidation loans work by giving you access to a lump sum of money you use to pay off your unsecured debts, like credit cards, in one fell swoop. You’re then left with only one payment on your new debt consolidation loan.
Debt consolidation loans are a smart way to pay off debt if you can qualify for a lower annual percentage rate compared to the average rate across your existing debts. This lower rate means you’ll save money on interest, and you’ll likely get out of debt faster.
These loans also have fixed rates and terms, so you’ll pay the same amount every month. This consistency makes payments easier to budget for than revolving debts like credit cards. Plus, you’ll know exactly what day you’ll be debt-free, which can be especially motivating.
Example of how a debt consolidation loan works
Let’s say you have three credit cards, each with a balance of $5,000, for a total of $15,000 in debt. These cards have an average annual percentage rate (APR) of 22%, and you’re currently making a monthly payment of $125 on each card.
At this rate, it’ll take you over six years to pay off the cards completely, and it’ll cost you a whopping $12,284 in interest.
Alternatively, say you pay off all your credit cards at once with a $15,000 debt consolidation loan that has a 13% APR and a five-year repayment term. With this new loan, you’ll save about $6,800 in interest and get out of debt a year earlier.
You’ll also only have one monthly payment to keep track of, and it’ll be $34 lower than your combined credit card payments. You can even apply that savings back to your monthly loan payment to get out of debt faster.
Here’s a breakdown of that example:
Credit cards | Debt consolidation loan | |
|---|---|---|
APR | 22%. | 13%. |
Monthly payment | $375. | $341. |
Payoff period | 6 years and 1 month. | 5 years. |
Interest paid | $12,284. | $5,478. |
Where can I find debt consolidation loans?
Online lenders: Debt consolidation loans from online lenders are available to borrowers across the credit spectrum, and they’re often the most convenient option. Some online lenders can make immediate approval decisions and fund loans the same or next day. Many also let you pre-qualify, so you can check your potential loan terms without hurting your credit score.
Credit unions: Credit unions may be more lenient to borrowers with fair or bad credit (scores below 690). You’ll need to join the credit union before applying for a debt consolidation loan. You can usually fill out the application online to join and make an initial minimum deposit as low as $5.
Banks: Banks may offer low rates on debt consolidation loans. You’ll likely need good or excellent credit (scores at 690 or higher) to qualify. If you already have a relationship with a bank, it’s worth asking about their loan options and qualification criteria before considering other lenders.
How do I qualify for a debt consolidation loan?
You qualify for a debt consolidation loan based on the information in your application. Lenders look at three core factors: credit score, credit history and debt-to-income ratio.
Some lenders publish minimum credit score or minimum credit history requirements to apply. Most like to see a good credit score and two to three years of credit history that shows responsible repayment behavior.
Steps to getting a debt consolidation loan
1. Add up your debts
The first step to getting a debt consolidation loan is knowing how much debt you have. Make a list of the debts you’d like to consolidate and add up the total, since this is the loan amount you’ll need to apply for.
You’ll also want to know the average annual percentage rate across your current debts. Your debt consolidation loan should have a lower rate — that way you’ll save money on interest and pay off the debt faster. Rates on consolidation loans range from 7% to 36% APR.
2. Pre-qualify if you can
Not all lenders offer pre-qualification, so take advantage of those that do. This typically involves filling out a short application with basic personal information, including your Social Security number.
The lender will run a soft credit check, which won’t hurt your credit score, and then display potential loan offers.
If your lender doesn’t offer pre-qualification, it doesn’t hurt to call and see what information they can tell you over the phone about applicant requirements, including minimum credit score.
3. Apply for the loan
Once you’ve pre-qualified or decided on a lender, it’s time to fill out your loan application.
A loan application asks for personal information — think name, birthdate, Social Security number, address and contact details. It also asks about the loan you want, like loan purpose, desired loan amount and repayment term.
You may need to show proof of identity, address, employment and income. Once you submit your application, you’ll undergo a hard credit check.
Most applications are available online, but a smaller bank or credit union may ask you to visit a branch. You can expect to hear back from the lender within a few days, though many lenders now provide same-day decisions.
4. Get funded and pay off your debts
Once approved, funding time is typically within a week, though some lenders provide same- or next-day funding.
Lenders can deposit the loan funds in your bank account, but some may offer to send the money directly to your creditors on your behalf. Once the lender sends the funds, check your accounts to confirm your balances are at $0.
If the lender doesn’t offer direct payment, use the loan funds to pay off your debts yourself.
5. Pay back your new loan
Once your debts are paid off, you’re left with only your new loan payment.
Your first payment is due one month after funding and will be due every month until the loan is paid off. Make sure you add this payment to your budget. Missing a loan payment can result in costly late fees and hurt your credit score.
When to avoid debt consolidation loans
You struggle to control spending: If you’re someone who has a hard time staying out of debt, loans can be risky. For example, if you use a debt consolidation loan to pay off your credit cards, but then start using your credit cards again, you’ll have even more debt than you started with. This can hurt your credit score and leave you struggling to repay your loan.
You can’t commit to years of payments: Terms on debt consolidation loans can be long – sometimes up to seven years, depending on the lender.
If you have good or excellent credit, you may want to consider other types of consolidation. For example, balance transfer cards often have 0% promotional periods. This can help you pay off debt faster, since there’s an interest-free window of up to 21 months.
You don’t end up qualifying for a low enough rate: If you can’t qualify for a lower rate than your existing debts, it probably doesn’t make sense to consolidate.
Check out NerdWallet’s free debt consolidation calculator where you can plug in your debts and figure out what rate you need to save money with a debt consolidation loan.
