Types of Debt Consolidation Loans

If your debt is spread out over many accounts — some or all with a high interest rate — you might benefit from a debt consolidation loan. Debt consolidation can get you a lower interest rate so more of your payment can go toward paying the principal balance (instead of just interest). It could even lower your payment as well.

To choose the best debt consolidation loan for your needs, it’s important to understand the different types available and how debt consolidation works.

How does debt consolidation work?

Debt consolidation is the process of using one loan — with a lower interest rate or monthly payment — to pay off several of your existing debts. So, instead of multiple monthly payments, you have a single payment you can afford.

Put another way, when you go through debt consolidation, you refinance your debt. You might want to obtain a debt consolidation loan to save money on interest, pay your debt off faster, or simplify your bill-paying routine.

There are five basic steps to consolidate debt:

1. Add up your debts, and determine how much you need to borrow.
2. Look at the interest rates you’re currently paying.
3. Find and apply for a debt consolidation loan with an interest rate lower than or equal to the rate you pay now.
4. Use the money to pay off your current debt balances. Your debt consolidation loan lender may send payments to your creditors on your behalf.
5. Repay your debt consolidation loan as agreed.

Learn More: How To Consolidate Bills

Personal loan for debt consolidation

A personal loan is a popular financial tool for debt consolidation. Once approved, you can use the funds for nearly any purpose, including paying off your current creditors.

Generally, personal loans have a fixed interest rate, giving you predictable and manageable monthly payments over the life of the loan. Usually, personal loans are unsecured, which means you don’t need to put up any collateral, like your car or home, to obtain funding. Repayment terms typically last from one to seven years, but some lenders offer even longer terms. And loan amounts can range from under $1,000 to over $100,000, depending on the lender and what you qualify for.

The average personal loan interest rate on a two-year loan was 12.49% in February 2024, according to the Federal Reserve, which is markedly lower than the average credit card interest rate, which was 21.59% for the same month. Because of this, personal loans are often a good choice for credit card consolidation.

For example, say you owe $20,000 on credit cards, at an average rate of 21.59%, and are making $500 per month payments. It would take you six years to pay off the balance, and you’d pay $15,832.01 in interest. If you consolidate the debt using a personal loan at 12.49%, you could lower your payment to $440, pay off the debt in five years and two months, and pay only $7,242.84 in interest — that’s less than half as much. Or, you could reduce your payment to $348, pay off the loan over seven years, and still save over $4,000 in interest ($10,770.37).

As long as you qualify for an APR lower than or equal to what you’re currently paying, debt consolidation with a personal loan could make sense.

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Credit card debt consolidation

A credit card balance transfer lets you move some or all of your debt on one credit card to another. Balance transfer credit cards frequently offer a 0% promotional interest rate for a limited time after opening the account (usually 12 to 21 months), but charge a balance transfer fee, which could be up to 5% of the amount transferred.

For context, a 5% fee on a $20,000 balance would be $1,000 (the balance transfer fee is added to your balance). And at a 0% APR, your monthly payment would need to be $1,000 to pay off the entire balance within 21 months.

If you can pay off your new card before the promotion ends, you could save a lot of money in interest. But if you can’t, your rate will adjust to the card’s standard rate. Plus, making late payments could void the promotional rate and therefore the benefits of the balance transfer.

Home equity loans and HELOCs

Your home’s equity is the difference between what your property is worth and how much you owe on your mortgage. For instance, if your residence appraises at $500,000 and you owe $375,000, you have $125,000 in equity. A home equity loan or home equity line of credit (HELOC) can help you use that equity to pay off your high-interest debt.

A home equity loan is a type of secured loan, because your home is collateral for the loan. This means that should you default on the loan, the lender could foreclose to seek payment. On the other hand, it also means the rate on a home equity loan is often lower than what you’ll find on unsecured loans, like most personal loans. Home equity loans typically feature a fixed interest rate and payment, which could last up to 30 years. You’d receive funds in a lump sum to disburse to your creditors to pay off your debt.

A HELOC works much like a credit card. You receive a line of credit with a credit limit to spend throughout what’s called the draw period. During the draw period, you may only have to pay the interest accruing on the debt. Draw periods generally last up to 10 years.

Once the draw period ends, you’ll enter the repayment period. During this time, you can no longer use your credit line. You’ll have to make full principal and interest payments until the debt is gone — the repayment period typically lasts up to 20 years.

In either case, your home is the collateral. If you don’t repay the debt as agreed, your lender could foreclose on your house.

Debt consolidation through student loan refinancing

If you have multiple expensive private student loans, it can make sense to refinance them if you can get a lower interest rate or a loan term that works better for your financial plans. However, you typically need excellent credit to qualify for the best rates.

If you have federal student loans, it’s generally not a good idea to refinance them with a private lender. This is because you’d forfeit benefits associated with federal student loans, such as income-driven repayment plans, loan forgiveness, and opportunities to use forbearance or deferment (while some private student loan lenders offer forbearance or deferment, not all do).

Choosing the right debt consolidation loan

There’s no one-size-fits-all way to become debt-free. The right debt consolidation loan for you depends on your financial situation.

For instance, a home equity loan or HELOC is off the table if you don't own your residence. Plus, even if you do own your house, you typically need a certain amount of equity in your home to get approved for a loan or line of credit — most lenders require at least 20% equity to qualify for a HELOC.

On the other hand, let’s say you have $300,000 worth of equity and $150,000 in non-mortgage debt you want to pay off. A home equity loan or HELOC could be your best bet because those financial tools may let you borrow more than a personal loan or balance transfer credit card, and at a lower rate. It also may be a better option if you don’t have good credit.

But if you’re uncomfortable putting your home on the line as collateral, a personal loan may be the better option. APRs range from around 5% to 36% — what you’ll be approved for depends on your credit score and financial profile. Like all loans, having excellent credit will net you the lowest rate.

But, if you want to pay as little interest as possible and can afford to pay off the balance within 12 to 21 months, a balance transfer credit card with a 0% promotional APR may work for you.

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FAQ

How do I get a debt consolidation loan?

You can get a debt consolidation loan by submitting an application through your chosen lender. However, prequalifying for several loans is a smart idea before applying. That way, you can compare your options and select the best loan for your financial goals.

How to get a debt consolidation loan with bad credit

It can be challenging to get a debt consolidation loan with bad credit, but it’s not impossible. You’ll need to prove to the lender that you’re not as great a risk to lend to as your credit score lets on. To do this, you can seek a secured loan, such as a home equity loan or HELOC, or a secured personal loan. Some lenders will also let you apply with a cosigner, which is a friend or relative with good credit who takes responsibility if you miss payments.

How to apply for a debt consolidation loan

You can apply for most debt consolidation loans online. Generally, you’ll need to provide personal and financial details, such as your name, contact information, Social Security number, employment status, and annual income. You may need to upload supporting documentation, like a copy of your photo identification or a recent pay stub.

Which is better: personal loan or debt consolidation?

A personal loan is just one debt consolidation method. Depending on your specific circumstances, it may or may not be the best solution for you. You might also consider consolidating debt with a balance transfer credit card, home equity loan, or HELOC.