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Should I Use a Personal Loan To Consolidate Debt?

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What You Need To Know

  • A personal loan is a popular approach to consolidating debt
  • Personal loans can offer flexibility, fixed interest rates and better terms than credit cards
  • If you have auto loan, student loan or home loan debt, there may be alternatives to personal loans for debt consolidation

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Whether it’s credit card debt or any other kind of debt, dealing with multiple payments every month can be frustrating.

Consider uncomplicating your life by rolling all your debt into a single monthly payment with a personal loan.

Debt consolidation is one of the most popular reasons why people get personal loans. 

But before you start looking for a personal loan to consolidate your debt, it’s a good idea to consider all of its details.

What Is a Personal Loan? 

A personal loan lets you borrow a lump sum of money from a bank, credit union or online lender to use as you see fit.

You agree to pay back the loan in monthly installments for a period that usually ranges from 3 – 5 years (or 36 – 60 months) at a fixed interest rate.

Wondering about the interest? Well, the average interest rate for a 24-month personal loan in the second quarter of 2021 was 9.58%.[1]

But that average isn’t carved in stone. How much you can borrow, and the interest rate you get, will depend on your income, credit score and credit history.

Using a Personal Loan for Debt Consolidation: The Pros and Cons

When it comes to consolidating and paying off debt, personal loans have lots of advantages – but there can be disadvantages, too.

Pros ✅Cons ⛔️
Lower interest rates:
Compared to credit cards, payday loans and other high-interest loans, personal loans can offer lower interest rates. 
Higher, locked-in payments:
With a personal loan, you’re locked into a fixed, monthly payment that will usually be higher than your smaller credit card minimums. You’ll have to make these higher payments consistently until your loan is paid off.
Consistent repayment terms:
You’ll know two things: how long it will take to pay off the loan and how much your monthly payment will be. (And what you owe doesn’t change – even if interest rates fluctuate over time.)
Not a cure for debt:
Using a personal loan for debt consolidation can help you manage or pay off your debt – but it can’t address the issues that got you into debt in the first place.

Use Personal Loans To Consolidate Debt if You …

Have high-interest debt

Please indulge us with this short (we promise!) math break. 

The average interest rate for personal loans in the second quarter of 2021 was 9.58%. During the same time, the average credit card interest rate was 16.30%. Are you already seeing what we’re seeing?[1]

Let’s round those numbers up and subtract 10% from 16%. That’s a savings of about 6% in interest when you consolidate your debt with a personal loan.

The numbers don’t lie (and the math break is over!). 

If you want to consolidate and pay off high-interest debt – like credit cards, payday loans or any kind of debt with an interest rate higher than 9% – a personal loan can help you to manage, reduce and pay it off.

Expect interest rates to go up

While no one can predict the market, if interest rates go up across the board, the interest rates on your credit cards will climb right on up with them. A benefit of consolidating your debt with a personal loan is that you get a fixed rate that doesn’t change over the life of the loan.

Want to stop worrying about paying multiple debts

Consolidating all of your debts can make your life easier because you’ll only have one payment to stay on top of each month.

Some lenders may even give you a discount on your interest rate if you sign up for an automatic monthly payment plan or set up a checking or savings account with them.

Don’t Use Personal Loans To Consolidate Debt if You …

Aren’t ready to take control of your debt

Consolidating your debt doesn’t get rid of it. Consolidating can offer much-needed relief and help you pay off your debt with a lower interest rate. But when all is paid off and calculated, you still had to pay back that original debt.

It’s in your best interest to use a personal loan to consolidate debt as a part of a larger debt reduction plan.

If you only manage to pile new debt on top of old debt, a consolidation loan may not improve your situation. And if you’re tempted to use your credit cards before you’ve paid off your personal loan balance, you could get buried under a mountain of debt.

Have bad credit

Every lender is different, but typically, the lowest interest rates are reserved for borrowers who have a credit score of 720 or higher.

If your credit score falls between 620 and 719, you can expect the interest rate you’re offered to be at least 3% higher than it would be if you had a higher credit score.

If your credit score is lower than 620, it’s less likely that you’ll qualify for a personal loan, and even if you do, its interest rate won’t be much lower than the rates on your credit cards.

It might make sense to press pause on the personal loan application and take some time to improve your credit score if it’s a hurdle to getting a competitive interest rate.

Don’t want to pay a loan origination fee

Personal loans often come with an origination fee. Sometimes referred to as the underwriting fee, administrative fee or processing fee. It’s what the lender charges you to process your loan.

As a rule, the origination fee for personal loans ranges from 0.5% – 1% of the amount you borrow. If you borrow $20,000, you can expect your starting loan balance to be $20,200 at most.

Personal Loan Not the Answer? Consider the Alternatives

Consolidating your debt with a personal loan can be helpful for some, but it may not be the solution to every circumstance.

Loan-specific refinancing options

Sometimes, a personal loan won’t get you the best rates. For secured loans, like home loans or auto loans, you may want to look into refinancing that’s specific to that type of loan.

You’re likely to get better interest rates than if you consolidated with a personal loan.

If you want to consolidate student loans, look into student loan consolidation and debt-restructuring programs for better loan terms and better interest rates.

Balance transfer credit card

If your credit score is stopping you from getting a low-interest personal loan or you want to pay off your debts quickly, a balance transfer credit card may be a better option.

These cards offer a low or 0% interest rate for a short introductory period, usually 6 – 18 months, which can help you consolidate debt and save on interest in the short term.

Once the introductory period is over, your interest rate will climb to where it was before – or get even higher. 

You’ll also need to pay a transfer fee (typically 2% – 5% of the balance you move). It gets added to your new balance, so make sure to factor that in when deciding if a transfer will save you money in the long run. 

Home equity loan or home equity line of credit (HELOC)

If you own a home and have at least 15% – 20% equity in your home, you can borrow against that equity at a lower interest rate than most personal loans with a home equity loan or HELOC.

These are secured loans – and your home is the collateral. Keep in mind that you risk losing your home if you can’t make your payments. 

As you’re figuring out the money-saving potential of this option, you’ll also need to factor in the annual fee you’ll pay on a HELOC and how much you’ll spend on closing costs, typically 2% – 6% of your loan amount.

Debt management plans

A certified nonprofit credit counselor can help you get your debt under control by providing the education and support you’ll need to consolidate your balances. 

Your credit counselor can also help you create a debt management plan. They will work with your credit card companies to create a payment plan that consolidates your debt, lowers the interest on your monthly payments and lets you pay off your debts over a fixed period of time.

Like a personal loan, all of your outstanding debt gets rolled into a single monthly payment, but you make your payments directly to the counseling agency.

Once your debts are consolidated and you’re put on a debt payment plan, you won’t be able to use your credit cards. 

And if you get calls from companies offering debt settlement plans – be careful. They’re often for-profit companies that promise to help you get rid of your creditors, but they may do more harm than good.

Thinking of Using Personal Loans To Consolidate Debt? Choose Wisely

If you’re ready to consolidate your debt, a personal loan could be a great way to do it. Make sure you understand the commitment you’re making. And make sure that it’s the best option for the type of debt you want to consolidate.

  1. U.S Federal Reserve. “The Fed – Consumer Credit – G.19” Retrieved August 2021 from https://www.federalreserve.gov/releases/g19/current/default.htm

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In Case You Missed It

Take-aways

  1. A personal loan can help you manage and consolidate debt, but to get the most out of the loan, create a plan to work on any existing debt issues
  2. Work on improving your credit score if it’s hurting your chances of getting a good interest rate on a personal loan
  3. If a personal loan isn’t right for you, consider balance transfer credit cards, home equity loans and debt management plans

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