What is a debt consolidation loan? 

From work to errands to making time for friends and family, there’s a lot to keep track of in our busy lives. But making debt payments on time is one task you can simplify. Enter debt consolidation loans. 

These loans can improve your financial life by helping you organize your debts—and they may even be able to help you get rid of your debt more quickly at a potentially lower cost. 

What is a debt consolidation loan?

Debt consolidation loans combine multiple debts that you already have into one new loan. When you take out a debt consolidation loan, you’ll only have to make one payment per month instead of multiple payments.

How does a debt consolidation loan work?

A debt consolidation loan does not pay off your debt. Instead, it moves your existing debts—like credit card balances, medical bills, or auto loans—to a single new loan, so you have fewer monthly payments to keep track of. 

The way a debt consolidation loan works is that you take out the loan and use the money to pay off your existing debts. Then, you pay off the debt consolidation loan with a single payment each month. 

In most cases, you’ll pay a fixed rate on a debt consolidation loan, meaning that the interest rate doesn’t change. Your monthly payment will be for the same amount each month until the debt is paid off. 

Benefits of a debt consolidation loan 

When you’re working on paying off debt, there are several ways a debt consolidation loan could help, depending on your situation. The pros of debt consolidation loans include: 

• Better organization. When you have fewer monthly payments to make, you’re less likely to miss a due date. 

• Potential to save money or improve cash flow. If your debt consolidation loan has a lower interest rate than your previous debts, you could reduce the total amount of interest you pay over time. The new loan could also have a longer repayment term, which may not save you money but could give your budget some wiggle room each month. 

• Positive impact on your credit profile. A lower credit utilization ratio, which means how much of your available revolving debt you’re using, is generally good news for your credit score. Paying off credit card debt with a consolidation loan would lower the amount you owe on that credit card and, as a result, could help improve your credit profile. 

A few things to note. There is no guarantee a debt consolidation loan will get you a lower interest rate, lower monthly payment, or longer repayment term. Also, even with a lower interest rate, if you take longer to repay the loan, you might not save on interest charges overall. 

Applying for a new debt consolidation loan is likely to cause your credit score to temporarily drop by a few points. After you get the loan, if you pay late or default on the loan, your credit standing is likely to suffer. 

Related: How online debt consolidation can streamline your finances

When is a debt consolidation loan a good idea?

Everyone’s financial situation is different, which means debt consolidation may or may not make sense for you. Consolidating your debt could be a good idea if the new loan has a lower interest rate than your current loans. It’s generally not advisable to take out a consolidation loan if it has a higher interest rate than your current loans.

The move may also make sense if you are having trouble keeping up with your multiple debt payments each month. Making one payment can ease the headache of paying, say, three different bills with varying due dates and amounts. 

Is it hard to get a debt consolidation loan?

The process to apply for a debt consolidation loan isn’t difficult, but you’ll need to meet a lender’s requirements. Those requirements vary by lender, but you can expect them to look for a minimum credit score, which is often between 620 and 700. They may also have a maximum debt-to-income (DTI ratio), which is the amount of your income that you spend on debt. 

If you find a lender whose requirements you meet and that fits your needs, it’s time to get your debt consolidation loan. You can do so by getting prequalified, applying, sharing your income details, and listing a bank account where your funds can be sent.

All in all, it can be fairly easy to get a debt consolidation loan if you have good credit and a steady income. If your credit score and DTI aren’t where they need to be to qualify for a loan, you could consider a debt resolution program. This involves asking a creditor to help settle your debts for less than what you owe. 

What’s a good APR for a debt consolidation loan?

A good annual percentage rate (APR)—that is the price you pay to borrow money—is one that is lower than what you’re currently paying. A lower APR means you’re paying less for your debt, and snagging one can improve your debt situation. 

What are the main kinds of debt consolidation loans?

A personal loan for debt consolidation provides you with money to reduce multiple debts at once so you can focus solely on paying down the one new personal loan. You can use a personal loan to consolidate debt such as medical bills, credit cards and retail cards, as well as other personal loans. Your eligibility for these loans usually comes down to your credit profile and overall financial situation. 

Another option is a home equity loan for debt consolidation. These can also be called second mortgages. Similarly to a personal loan, you can use a home equity loan to get a lump sum of money that you use to pay off your other loans. They can come at a lower borrowing cost than other types of loans since the lender is using the house as security to ensure you make your payments. 

What’s next? 

• Review your debt. If you’re interested in debt consolidation loans, you likely have multiple debts. Check how much you owe, what your various interest rates are, and how long you have to pay down those debts.

• Check your credit. Understanding your credit profile is a key part of getting a debt consolidation loan. You may want to boost your credit score if it won’t meet lenders’ requirements yet.  

• Seek help. Having debt can feel overwhelming, but there are ways to strengthen your financial situation. Talk to a debt expert to determine how to best get rid of your debt.