How To Get a Debt Consolidation Loan With Bad Credit

Debt consolidation loans can help you lower your interest rate, reduce the number of monthly payments you make, and simplify your overall finances.

Unfortunately, it can be more challenging to get a debt consolidation loan if you have bad credit. You may be subject to higher interest rates and may not qualify for a loan at all.

The good news is that even if you have bad credit, there are steps you can take to improve your chances of qualifying for a debt consolidation loan and improving your finances.

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1. Check your credit history

Knowing your credit score and what’s on your credit report will give you a good idea of whether you can qualify for a loan, and what improvements you can make to your score.

Additionally, it’s critical to check your credit history for errors. About 34% of consumers found errors on their credit reports, according to a 2021 study by Consumer Reports. While some errors may simply be incorrect personal information, others can be accounts that aren’t yours, which could damage your credit.

2. Improve your debt-to-income ratio

Your debt-to-income ratio (DTI) is the percentage of your gross monthly income that goes toward debt. Generally speaking, a lower DTI is better, and lenders generally have a maximum allowable DTI to qualify for a debt consolidation loan. Most lenders prefer a DTI no higher than 35%.

If you have a high DTI, you may need to work on reducing your debt before qualifying for a debt consolidation loan. Some strategies to consider include using the debt snowball or debt avalanche methods. At the same time, consider reducing your monthly spending and using a budget to help allocate more money toward debt.

Another way to reduce your debt, and therefore your DTI, is to negotiate with your creditor or lender to either lower your interest rate or settle your debt for a lower amount.

Learn More: What Is Debt-To-Income Ratio?

3. Compare loan rates

One of the most important steps in getting a debt consolidation loan is doing your research and shopping for the best loan rates and terms. Personal loan interest rates can vary dramatically from one lender to the next. And if your credit isn’t in the best shape, you might get vastly different quotes.

Here are a few factors to consider when comparing different debt consolidation loan offers:

• Interest rates
• Loan amounts
• Repayment terms
• Origination fees
• Prepayment penalties

Keep in mind that if you have poor credit, you likely won’t qualify for the lowest rates available. But comparing lenders can still help you find the best rate for your circumstances. 

Secured loans vs. unsecured loans

When applying for a personal loan, you can choose between an unsecured and a secured loan. Most personal loans are unsecured, meaning they aren’t backed by any collateral. The benefit is that you don’t risk losing any assets, such as your car or house, if you can’t repay the loan. However, unsecured loans may be more difficult to qualify for and have higher interest rates.

If you have bad credit, you may be better off applying for a secured personal loan. You’ll have to provide an asset to use as collateral, which creates an added layer of risk. However, you may be more likely to qualify and get a better interest rate.

Pros and cons of debt consolidation

There are many reasons to pursue debt consolidation, but while it comes with several benefits, there are also some downsides to consider before applying for a loan.

Pros

• Potentially lower interest rate: For many people, consolidating their debt allows them to get a lower interest rate, especially when using a personal loan to consolidate credit card debt. In the long run, you’ll save money and have more cash to put toward your loan principal.
• Fewer monthly payments: When you consolidate your debt, you’ll have just one monthly payment on your debt consolidation loan instead of making separate payments for each of your debt accounts.
• Faster repayment: When you have a lower interest rate and fewer monthly payments, you may find you can be more aggressive with your repayment and pay your debt off more quickly than you’d otherwise be able to.
• Improved credit: Debt consolidation can improve your credit for several reasons, including paying off past-due accounts, lowering your credit utilization, and improving your payment history as you pay off your loan.

Cons

• May be difficult to qualify: If you have bad credit, you may struggle to qualify for a debt consolidation loan. And if you do qualify, you may have less-favorable interest rates.
• Loan fees: Debt consolidation loans often require an upfront origination fee, late fees, and even prepayment penalties when you pay your loan off early. These fees can amount to hundreds or thousands of dollars, depending on the size of your loan.
• Can put assets at risk: If you have difficulty getting an unsecured personal loan and instead apply for a secured loan, you put certain assets at risk. If you fail to repay your loan, the lender can take whatever asset you used as collateral.
• Persisting financial problems: Consolidating your debt won’t usually help address the underlying issues that caused you to go into debt, including too little income or trouble with impulse spending. You must address those underlying issues separately.

How to apply for a debt consolidation loan

Here’s how to apply for a debt consolidation loan:

1. Check your credit score: Before applying for any loan, it’s always important to check your credit score first. You’ll have a better idea of whether you’ll qualify for a loan and what lenders you should consider.
2. Prequalify: Many lenders allow you to prequalify for a personal loan, which allows you to see if you’re likely to qualify and to check your rate without affecting your credit score. Consider prequalifying with multiple lenders to compare offers.
3. Compare your loan offers: Once you’ve been prequalified by several lenders, it’s time to compare loan offers. Compare interest rates, fees, repayment terms, and other factors to decide on the best lender.
4. Apply for a loan: Once you’ve chosen the best lender, you’ll officially apply for the loan. During this process, expect to provide financial information to verify your income, employment, and ability to pay.
5. Get your loan funds: After your loan application has been approved, you’ll receive your funds. The funding time varies from lender to lender, but many online lenders will provide your loan funds either within one business day of approval or a few days.

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How to improve your credit score

If your credit score isn’t ideal, there are ways to improve it. Here are a few steps you can take:

1. Dispute credit report errors: If you find errors on your credit report, dispute them directly with the credit bureaus. Assuming the reports are incorrect, they’ll be removed from your credit report, along with any negative impact they had on your credit score.
2. Address past-due debts: If you have any debts that are currently past due, pay them as soon as possible. Yes, your missed payments will still appear on your credit report. But getting out of delinquency will help improve your credit.
3. Get a credit-builder loan: Credit-builder loans come with shorter repayment terms — from six months to two years — and your funds are deposited into a savings account with your lender. With this type of loan, you’ll make regular principal and interest payments that are reported to each of the three major credit bureaus, and you’ll get your funds back at the end of the loan term.
4. Improve your payment history: Your payment history is the most important factor determining your credit score. Do whatever is necessary to avoid missing payments, including setting up autopay or adding your due dates to your calendar.
5. Reduce your credit utilization: You can improve your credit score by using a smaller percentage of your credit limit. If you currently have credit card debt, consider paying some of it off before applying for a debt consolidation loan.
6. Become an authorized user: This is one of the fastest and most effective ways to improve your credit score. Ask a loved one with good credit to add you as an authorized user on their credit card. You’ll get credit for the positive payment history on your credit report, which can quickly boost your credit score.

Learn More: Where to Get a Personal Loan

Alternatives to debt consolidation

A debt consolidation loan can be a great option to help you manage your debt, but it’s not the only option. Here are a few alternatives to consider:

• Debt management plan: This type of plan involves working with a credit counselor, who negotiates with your creditors to lower your interest rates, waive fees, or adjust your loan in other ways. You’ll make payments directly to the credit counseling organization, which will distribute them to your creditors. The National Foundation for Credit Counseling can help you find a nonprofit credit counseling agency.
• Home equity loan or line of credit: These options allow you to borrow against your home equity. Like a personal loan, the money can be used for nearly anything. Because the loan is secured by your home, you’ll often get a lower interest rate. However, because your home is used as collateral, you risk foreclosure if you can’t repay the loan.
• Balance transfer card: If you have credit card debt, you can use a balance transfer to move your balances to a different credit card. The benefit is that many credit cards offer introductory APR periods where you’ll pay 0% interest on your balance transfer for anywhere from six months to two years. If you go this route, ensure you can repay the debt within the 0% introductory APR period to avoid paying the card’s regular APR.
• Debt settlement: When you go through a debt settlement program, a company works to settle your debt on your behalf. The goal is to negotiate with the lender to get them to agree to take a reduced amount. Debt settlement programs often require you to stop making payments, which can harm your credit and possibly lead to legal action from your creditors, so proceed with caution.
• Bankruptcy: This should be a last resort to help you manage your debt. Bankruptcy is a court process that discharges certain unsecured debts, helping you get a fresh start. However, bankruptcy will stay on your credit report for seven to 10 years, can be detrimental to your credit score, and doesn’t discharge all types of debt.

Related: Debt Consolidation vs. Balance Transfer

FAQ

What credit score do I need to qualify for a debt consolidation loan?

The credit score you need to qualify for a debt consolidation loan depends on the lender. Depending on the lender, some offer loans to borrowers with credit scores as low as 300-500. However, borrowers with good or excellent credit will qualify for the best interest rates.

Can I get a debt consolidation loan if I have a low income?

You may be able to get a debt consolidation loan with a low income if you have a sufficient debt-to-income ratio (DTI). In addition to looking at the amount of income you earn, lenders consider your DTI to determine whether you have room in your budget for a loan.

Will applying for a debt consolidation loan affect my credit score?

Many lenders allow you to prequalify for a debt consolidation loan, which won’t affect your credit score. However, once you apply for and borrow the loan, you will see an impact on your credit. New loans often have an immediate negative impact on your credit score because lenders run a hard credit check, but these loans can have a positive impact over time.

How long does it take to get approved for a debt consolidation loan?

Some lenders can approve you for a personal loan the same day you apply. In other cases, it may take days or weeks to verify your information and determine whether you qualify.