Key learning points
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Debt consolidation can be accomplished with a personal loan or credit card, depending on your needs.
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Competitive rates typically go to people with good to excellent credit: FICO credit scores of 670 or more.
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Look for an interest rate that is on average lower than your current debt to get the best deal.
Debt consolidation involves combining multiple debts into one account to reduce the number of bills you pay each month. Ideally, you will also reduce the overall interest rate and ultimately be able to pay off the debt faster.
Are you considering taking out a debt consolidation loan to help you pay off your debts faster? You will need to evaluate your finances and credit score to determine which consolidation method is best for you. Take the time to understand how debt consolidation works before signing up.
How to choose a debt consolidation loan: factors to compare
When choosing the right lender for you and your needs, consider factors such as the type of loan, interest rates, fees and repayment options.
Type of loan
There are multiple debt consolidation options to choose from, each with its pros and cons. Selecting the best option for your needs is important as this will help you choose the type of lender.
When it comes to debt consolidation, these are the most common types of loans you’ll encounter:
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Many lenders offer personal loans designed to help you pay off your debt faster and save on interest.
These loans, also called debt consolidation loans, have a fixed interest rate and a fixed repayment term. The idea is to pay off your outstanding debt with the loan and then make a single payment each month. -
Also known as balance transfer credit cards, these cards offer an interest-free introductory period, typically ranging from 12 to 18 months. They are generally reserved for consumers with good or excellent credit. Only consider this option if you can pay off the new card during the introductory period. After this, you will face typical credit card rates.
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You can convert up to 85 percent of your property’s equity into cash and use it to consolidate debt with a mortgage loan. It acts like a second mortgage with a five-year repayment term ranging from five to 30 years. The interest rate is also fixed and lower than most credit cards. The big disadvantage is that your house serves as collateral. You could lose your property if you fall behind on your loan payments.
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A HELOC is like a home equity loan, but you don’t receive the loan proceeds all at once. They work more like a credit card. You can withdraw money as needed during the draw period, up to a certain limit. During the draw period, most HELOCs require only interest payments. Once the term expires, you repay in monthly installments over a period of 10 to 20 years.
Approval Requirements
As with all financial products, your credit score is important to determine your eligibility. Pay attention to each lender’s credit score requirements. Lenders also set a maximum debt-to-income ratio (DTI).
Both factors allow you to select lenders who will work with borrowers with your credit profile. This can save you time. You will not apply to lenders who are very unlikely to approve you.
Loan amounts
Before choosing a debt consolidation provider, determine how much debt you need to consolidate. Check your debt balances and request payout amounts, which will be slightly higher than your current balance. Once you have this number for each debt you want to consolidate, you can start looking for a new lender.
Lenders limit the amount you can borrow. Make sure to check the maximum beforehand so you can consolidate all your accounts into one new account.
Interest rates
Even if a lender has a low starting rate, this will be reserved for people with excellent credit. Instead, check the maximum annual percentage rate (APR) a lender charges to ensure a loan is still affordable even if you don’t qualify for the lowest rates.
To get an idea of what interest rate you can get, make sure you pre-qualify with multiple lenders that you think will best suit your needs. By pre-qualifying, you can see if you qualify without damaging your credit.
Cost
Almost every lender charges costs for borrowing. These often include late fees, origination fees, or prepayment penalties. However, some lenders do not charge any fees. If you have good to excellent credit, you may be able to qualify for one of these — or at least work with a lender that has fees on the lower end of the spectrum.
Some fees, such as late fees, are avoidable and depend entirely on your ability to pay on time. Others, such as origination fees, are determined by the amount you borrow.
A lender may charge between 0 and 12 percent of your requested amount as an origination fee, and this amount will be deducted from your final loan amount. Make sure you take the origination fee into account when determining the amount you want to borrow.
Refund options
You should choose a lender that offers terms that fit your monthly budget. But beyond payment, you need to calculate the total consolidation costs and compare them to the costs of paying each bill separately. If you’re not careful, consolidating could end up paying you more in interest than if you kept your debts separate.
Keep in mind that the longer the term of your loan, the more time there is before interest accrues. Choose a shorter loan term to reduce the total amount you pay. Make sure you can afford the monthly payments and manage the loan.
Unique features
Many lenders offer special features specific to their products. Find out what’s important when deciding which benefits will sweeten the deal.
One to look for when comparing debt consolidation loans are lenders that offer direct payments to creditors. Additionally, some may offer rate discounts for things like automatic payments, which can make your loan even more affordable.
Customer service
If navigating technology isn’t your strong suit, you may prefer to work with a lender that offers personalized support. Borrowers who prefer the convenience of online assistance should look for lenders that have virtual assistance options.
Debt consolidation loan interest rates
A debt consolidation loan can offer a lower interest rate than most credit cards. According to data from Bankrate, the average personal loan currently has an interest rate of about 12 percent. That said, interest rates on debt consolidation loans range from about 7.5 percent to 36 percent. If your credit score is fair or poor, you may see rates at the higher end of the range.
Your credit score, debts and monthly income can affect the interest rate and terms of the loan.
You’ll likely receive average rates with a FICO score around 670. For the lowest rates, you’ll often need a credit score between 800 and 850.
Lenders also consider factors such as your citizenship, involvement in bankruptcy or foreclosure proceedings, DTI ratio and income.
If credit is less than excellent, you may get a more competitive rate through a secured loan. Because these loans require collateral for approval, they typically offer lower interest rates compared to unsecured loans. However, if you default, the lender can use your collateral to recoup its investment.
Next steps
Before applying for a loan or credit card to consolidate your debts, decide which type of debt consolidation or alternative makes the most sense. Be sure to pre-qualify with at least three lenders to see potential loan costs and compare your options. Doing this will help you make an informed decision.
