Credit card debt is a fact of life for millions of Americans. The average credit card debt per borrower is $5,472, according to TransUnion’s Q1 2018 report. If you, too, are struggling to pay off your credit cards, a debt consolidation loan could be your best bet.
You’re probably making monthly payments to multiple creditors — on different dates and for different amounts at varying interest rates — which is confusing and expensive. Debt consolidation simplifies your monthly payments and helps you pay off your debt.
What is a debt consolidation loan?
A debt consolidation loan is typically a personal loan from a lender given in one lump sum, which you use to pay off credit card balances or other qualifying debt. You then pay back the loan in fixed monthly payments over the course of a set number of months.
In general, debt consolidation loans make sense when they offer better terms and lower interest rates than the credit cards you’re paying off, allowing you to get rid of your debt more quickly (and cheaply).
Where to find debt consolidation loans
Debt consolidation loans are available from three main sources and financial institutions.
1. Online lenders
Many online lenders generally offer lower rates and loans to individuals whose credit scores may disqualify them from traditional banks and credit unions. Credible provides you with a platform to compare prequalified rates from several online lenders in one place, so you don’t have to submit individual requests to all of them separately.
2. Credit unions
Non-profit credit unions typically offer better rates and terms with simpler applications than traditional banks, but you usually need to be a member to get a loan there.
3. Traditional banks
Not all banks offer personal loans for debt consolidation or any other purpose, but many do. Typically, the debt consolidation loan rates and terms banks offer are worse than the other options and the credit score qualifications are more stringent. If you have a long-standing relationship with a bank, though, it’s worth asking what they can do for you.
How to choose the best consolidation loans
Choosing the best consolidation loan for your situation can be difficult and overwhelming since you have so many loan options. But here are the main steps to take so that you can choose the loan that works for you.
1. Review the requirements
The first step is to know what the requirements are for a debt consolidation loan. Although each lender uses a different formula to determine your creditworthiness, most take into account these common factors when assessing your loan request:
- Credit score: Your credit score is usually the most important factor. If you have good credit (typically above 720), you’re more likely to qualify for a loan.
- Credit report history: Many debt consolidation lenders will want to see a credit history of at least one to three years with no bankruptcies within the past one to two years. They might also consider the number of credit inquiries you’ve had over the last year, your open credit lines, and any delinquent payments or charge-offs.
- Employment status: Lenders might require proof of income and some will require a minimum household income to qualify for a loan (frequently between $20,000 and $40,000, though it varies).
- Debt-to-income ratio: Your debt-to-income ratio is all your monthly debt (including housing payments) as a percent of what you earn each month before taxes. Generally, lenders consider DTI ratios under 36% as the best. Higher than 50% is usually considered poor.
2. Get prequalified
With Credible, you can submit some basic personal information, the loan amount you’re interested in, and an estimate of your credit score to see if you’re eligible for a loan and what rates you prequalify for. Checking prequalified rates for loans on Credible will not affect your credit score.
Once you receive prequalified rates, you can submit a formal application for the loan option that is best for you. When you actually apply for a loan, however, you trigger a “hard pull” on your credit which affects your credit history.
But the hit your credit score takes with a “hard pull” may be more than counterbalanced by the benefits the loan provides your credit. Loan installment payments are generally better for your credit score than credit card debt, even if the total debt you’re paying off is the same. So erasing the maxed-out debt on those cards and replacing it with a loan may give you a credit boost.
3. Consider your options carefully
It might be tempting to jump on the offer with the lowest monthly payments, but you’ll want to weigh other factors as well to ensure you’re making the best decision for your situation.
When evaluating the costs of different loans, you’ll want to consider the following:
- Total cost: For each offer, you should determine the amount you’ll actually end up paying at the end of your loan term, not just your monthly loan payment. If your monthly payment is lower, but stretched out over a long time, it could cost you more than paying credit card minimums since interest will keep accruing.
- Origination fees: Most lenders charge you origination fees when you take out a loan. This is typically a percentage of the overall loan amount, usually between 1% and 6%. Look for lenders instead who have no fees.
- Prepayment penalties: Some lenders don’t want you to pay off your debt early and will penalize you if you do so. This fee will vary depending on when in the loan’s life cycle you pay it off, so be sure to check if there are any prepayment penalties.
- Late fees: Lenders typically tack on a fee for late monthly payments either as a percent of the monthly payment or a flat amount.
- Scams: If a lender says your loan is “guaranteed” without getting much information from you, or if they charge you a fee upfront just to process your request — stay away. People saddled with high-interest credit card debt can be easy targets for scam artists, so make sure you’re only working with reputable lenders, like those on Credible.
Debt consolidation loan alternatives
If you don’t meet all of the requirements for a debt consolidation loan, but are still struggling with credit card debt, you still have other debt consolidation options. Here are a few to consider:
- 0% APR credit card: Many credit cards offer a 0% introductory rate that, in some cases, applies to balance transfers. You might want to open a balance transfer credit card for your existing credit card balances and use the introductory period — which can be as long as 21 months — to pay your debt off. Just make sure you’re able to get the card paid off before the promotional rate expires or you’ll be stuck paying high credit card interest rates all over again.
- Home equity loan: If you own your home, you might qualify for a home equity loan that you can use to consolidate debt. You can get lower rates on home equity loans than on personal loan. But you’ll need to weigh the pros and cons in your particular situation — some experts say you should only take out home equity loans to pay for things that increase your home’s value. But it may be your best choice depending on your other options.
- Student loan refinancing: If the debt you’re struggling with isn’t on credit cards, but instead you’re burdened by student loans, a personal loan for debt consolidation won’t work. However, you still have other options to help with your student loan debt like a federal Direct Consolidation Loan or student loan refinancing.
Take the time to research and weigh all of your options before deciding if loan consolidation is the best solution for you. Although using a personal loan for debt consolidation can be a great way to to get out of debt, it won’t won’t fix all of your bad financial habits.
The psychological effect of being debt free and having a clean slate might tempt you into racking up a new round of debt, but be honest with yourself about what got you into trouble to begin with. Addressing any bad spending habits now is important to your long-term financial health.
Leah Schmerl contributed to the reporting for this article.