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Debt Consolidation vs. Personal Loan: What’s the Difference?

Debt consolidation can combine your debts into a single payment, offering several benefits such as streamlining repayment and potentially a lower interest rate.

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By Emily Batdorf

Written by

Emily Batdorf

Writer

Emily Batdorf is a personal finance expert, specializing in banking, lending, credit cards, and budgeting. Drawing on her scientific background, she's developed a knack for analyzing financial products in the context of different needs. She finds joy in helping readers understand their best options and shuns a one-size-fits-all approach.

Edited by Jared Hughes

Written by

Jared Hughes

Editor

Jared Hughes is a personal loan editor for Credible and Fox Money, and has been producing digital content for more than six years.

Updated May 17, 2024

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If you have debt, you may be unsure how to get out from under it. Fortunately, a debt consolidation loan, which is a type of personal loan, can be used to pay off your existing debts and possibly reduce your interest rate. In the right circumstances, they can streamline your payoff strategy.

Understanding debt consolidation

Debt consolidation is the process of combining your existing debts into one by taking out a new personal loan or line of credit. Once you take out the loan, you pay off your existing debts, then pay off your new loan in monthly installments.

In some cases, debt consolidation can help you secure a lower interest rate, lower your monthly payments, or pay off your debt more quickly. Regardless of these benefits, one of the biggest advantages of debt consolidation is the fact that it simplifies your finances. Instead of making payments toward several debts each month, you only have one payment to worry about.

On the other hand, debt consolidation isn’t a quick fix for getting out of debt or other financial problems. Consolidating debt doesn’t make it disappear — it just reorganizes it into a (hopefully) more manageable loan and can make it easier to stay on top of your monthly payments.

For example: Let’s say you have three loans totaling $12,000. Your average personal loan interest rate is 19%. You’ll pay off these loans in 24 months with a combined monthly payment of $605 between the three debts. After two years, you’ll have paid off the loans and a combined $2,518 in interest.

However, say you find out you can consolidate your debt with a personal loan that’s charging only 14.5% interest. With the same repayment term of 24 months, you’ll pay off your $12,000 debt with monthly payments of $579. And your interest over 24 months with your new loan would be just $1,896.

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What to consider before consolidating debt

As the above example shows, debt consolidation loans can help you save money. But it doesn’t always work out that way — and it’s not best for every situation. Sometimes, debt consolidation won’t be worth the fees and administrative work. Other times, your situation may be at the point where debt relief is the better option.

Here are some factors to consider before deciding to consolidate your debt.

  • Your total amount of debt: If you have a ton of debt, along with a high debt-to-income ratio (DTI), debt consolidation may not be the best idea. In fact, most lenders prefer a DTI no higher than 35%. So a high DTI may make it tough to qualify for a debt consolidation loan at all. If you're drowning in debt, a debt relief strategy is probably a better option.
  • Your interest rates: If your current interest rates on your loans are already low, it may not be worth getting a debt consolidation loan. But if you have high interest rates on your debt — and you think you could qualify for a lower rate with your current financial situation — it may be a good idea.
  • Repayment terms: If you have a plan to pay off your current loans within a year, it may not be worth consolidating. The time and fees required to consolidate may not be worth the benefit of doing so. But if you still have years of payments to go, consolidating with a lower interest rate is often worth it.
  • Your monthly payment: You should only consolidate if you can afford your new monthly payment. So if you can’t qualify for a loan that offers a manageable monthly payment, consolidating isn’t a good idea.
  • Your financial habits: Debt consolidation has the potential to help you get out of debt, but it won’t change your spending habits. If you’re still spending beyond your means, consider addressing the underlying issues before attempting debt consolidation.

Check Out: Debt Relief Programs: Options to Reduce Debt

Can a debt consolidation loan hurt your credit score?

Debt consolidation can impact your credit score. Whether it has a positive or negative impact depends on your financial habits.

Initially, consolidating your debt can have a slight, temporary, negative impact on your credit score. That’s because when you apply for a loan, the lender performs a hard credit check. This credit check temporarily lowers your score. After consolidating, your score can continue dropping if you fall behind on payments or miss them altogether.

On the other hand, debt consolidation can also help your credit. By consolidating your payments into one, debt consolidation can help you keep up with your payments more easily. By making payments on time — and eventually paying off your loan — you can gradually improve your credit score. Plus, a debt consolidation loan can diversify your credit mix and reduce your credit utilization — both of which have positive impacts on your credit score.

How to apply for a debt consolidation loan

Applying for a debt consolidation loan is similar to applying for other personal loans. But the process can vary by lender. Generally, you can apply and qualify by following these steps:

  1. Check your credit score: It’ll be easier to qualify for a personal loan with good credit. Check your score before you start applying for an idea of the rates you can get. If your score isn’t great, consider trying to improve it before applying for a new loan.
  2. Compare lenders and pick a loan: Research different lenders to narrow down your best options. Certain lenders may even let you prequalify for a loan to get a better idea of the interest rate you’re likely to get — without hurting your credit score. When picking a loan, make sure it has terms that work for you. Use a personal loan calculator to estimate monthly payments, and make sure you can afford them.
  3. Complete the application and get your funds: After choosing a loan, you can typically apply online. You’ll need to provide some documentation, like multiple forms of ID, proof of employment, tax forms, and proof of address. After verifying your information, the lender will approve (or reject) your application. Then it can take a matter of days or weeks, depending on the lender, for you to receive the funds.
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700

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620

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660

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8.49% - 35.99%

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Min. Credit Score

600

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8.98% - 35.99%

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550

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Debt consolidation loan alternatives

A debt consolidation loan isn’t the only way to tackle your debt — and in some cases, it’s not a realistic or helpful option. Below are a few alternatives you may want to consider.

  • Balance transfer card: A balance transfer credit card allows you to combine credit card balances onto another card — for a fee. If you can qualify for one, your card could come with an introductory period of 0% interest, which can be extremely valuable if you can aggressively pay down your balance in that time. Keep in mind the APR will likely jump up dramatically at the end of the introductory period.
  • Home equity line of credit (HELOC):A HELOC allows you to borrow against the equity you have in your home, making it a secured line of credit. If you have significant equity in your house, this could be a good option. Because HELOCs are secured, they tend to have lower rates than personal debt consolidation loans, but you risk foreclosure if you miss payments.
  • Debt management plan: A debt management plan involves working with a nonprofit credit counseling agency. Typically, a debt management plan is for people who want professional help getting a handle on their debt. With a debt management plan, the agency will create a payoff plan, negotiate your interest rates, and handle the payments to your creditors in exchange for a small fee.

Related: Debt Consolidation vs. Balance Transfer

FAQ

Can I consolidate all types of debt?

Generally, you can consolidate all types of debt. Typically, however, debt consolidation makes the most sense for high-interest debt, like personal loans and credit card debt. Some types of debt consolidation loans may have limits on how you can use them — for instance, most lenders prohibit using personal loans to pay off student loans.

Can I still use my credit cards after consolidating my debt?

Usually, you can still use your credit cards after consolidating debt. But if you enroll in a debt management plan, you probably won’t be able to use your credit cards. Debt management plans typically require you to stop taking on debt while in the program. In exchange, these plans typically offer lower interest rates on your behalf.

How long does it take to pay off debt through consolidation?

The amount of time it takes to pay off your debt through consolidation completely depends on your financial situation. The following factors play into it: the amount of debt you have, your interest rate, and the size of your monthly payment. The more debt you have, the higher your interest rate, and the smaller your monthly payment, the longer it will take to pay off your debt through consolidation.

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Meet the expert:
Emily Batdorf

Emily Batdorf is a personal finance expert, specializing in banking, lending, credit cards, and budgeting. Drawing on her scientific background, she's developed a knack for analyzing financial products in the context of different needs. She finds joy in helping readers understand their best options and shuns a one-size-fits-all approach.