A debt consolidation loan may help you transfer multiple high-interest credit balances into one account, ideally with a lower annual percentage rate (APR). You may also consolidate your debt with a longer loan term to reduce your monthly payment, although doing so could result in owing more interest. You can apply for a debt consolidation loan by following these five steps.
1. Evaluate Your Financial Situation
Before starting the process, take stock of your debt and weigh the pros and cons of debt consolidation to determine if a debt consolidation loan is a good option. Here are some reasons debt consolidation may make sense:
- Saves money: If you have a lot of high-interest debt, often from credit cards, a debt consolidation loan can reduce the total amount you pay over time. The average credit card interest rate is 18.43%, while the average rate for personal loans is 10.16%, according to the Federal Reserve. A debt consolidation loan could still work for you even if you have bad credit. Use a credit card payoff calculator to run the numbers and see if debt consolidation could save you money.
- Built-in repayment plan: With revolving credit like credit cards, you borrow and repay funds on an ongoing basis, with no end date in sight. By contrast, personal loans come with a repayment term, typically two to five years, which can make budgeting easier.
- Get out of debt faster: Choosing the shortest loan term you can comfortably afford allows you to accelerate your repayment schedule and get out of debt faster.
- Reduces your payment: Opting for a longer loan term may lower your payment, but be aware you'll likely pay more in interest charges over time.
Of course, using a personal loan to consolidate debt may not be a good option for the following reasons:
- May receive a higher interest rate: If your credit is below average, you may not qualify for a lower interest rate than what you currently pay. In that case, consider taking the time to improve your credit before applying for a personal loan.
- Could increase debt: Consolidation loans give you the opportunity to zero out your credit card debt by transferring it to a single installment loan. If you rack up charges on your newly freed-up credit cards, you could end up with more debt than when you started.
- Low debt balance may not be worth it: If you can pay off your existing debt in less than a year, the savings from a debt consolidation loan may be too minimal to be worthwhile.
2. Check Your Credit
Next, get a copy of your credit reports and review them for accuracy. You should also understand your credit scores because debt consolidation lenders will review your credit reports and scores when deciding whether to approve you for a loan. (Familiarize yourself with credit scoring ranges and what is considered a good score.) Your scores will also help lenders determine your APR.
If your score is in the good or excellent range, you probably have a strong chance of getting approved for a personal loan with a low APR. But if your credit is in the fair to poor range, it may be a little trickier to consolidate your debts. However, there are loans geared toward people with less established credit or lower credit scores. Just keep in mind that applicants with lower credit scores often receive higher interest rates on their new debt, so it's important to pay attention to the rates when you apply.
3. Compare Debt Consolidation Loans
Taking the time to shop around and compare multiple loan offers can help ensure you get the lowest rate on a debt consolidation loan. Follow these tips to make sure you get the best loan possible while addressing other concerns:
Get the Best Terms Possible
Since a debt consolidation loan is supposed to save you money, it's important to make sure your new interest rate is lower than your existing rates. Review all your borrowing options before picking a debt consolidation loan, as some may offer better terms and benefits than others. In addition to your own bank, check out other banks and credit unions, as well as Experian's marketplace for a full selection of debt consolidation loans.
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Look at the Lifetime Cost of the Loan
This calculation will help you understand how much money you can save in interest by using a debt consolidation loan.
Say you have $5,000 in credit card debt with an average APR of about 25%. Over 36 months, your monthly payment is approximately $199, and you will pay a total of $2,157 in interest. If you consolidated this debt into a new loan with an average APR of 17% over 36 months, the total amount you'd pay toward interest would drop to around $1,417, and your monthly payment would come down to $178. Over the life of this loan, you will have saved approximately $739 in interest.
Beware of Penalties and Other Fees
Many loan products come with origination fees or prepayment penalties that could be quite steep. For example, origination fees typically cost 1% to 8% of the borrowed amount. If you plan on paying off your consolidation loan early, make sure your loan doesn't include a prepayment penalty, which could cost you up to 2% of your outstanding balance.
4. Apply for a Debt Consolidation Loan
Once you select the best loan offer that suits your needs, it's time to apply. Usually, this involves providing personal, employment and income information and your reason for borrowing.
Your lender may ask you to present documents that support the information on your application, such as:
- Government-issued photo ID
- Pay stubs
- Bank statements
- Proof of residence
Your lender will typically review the information on your application and perform a hard inquiry of your credit file. They're likely to look at your debt-to-income ratio (DTI), which compares the total amount of your monthly debt payments with your monthly income. As a general rule, lenders prefer DTIs under 36%, but many approve debt consolidation loans for applicants with larger debt.
5. Close the Debt Consolidation Loan
Upon approval, the lender will fund your loan in one of two ways:
Disbursing funds to creditors: Your lender may disburse your loan proceeds to your creditors to pay off your old debt accounts. Protect your credit by continuing to make payments on these accounts until your creditors verify they are paid off and closed out.
Directing funds to you: Your lender could elect to deposit the funds directly to your bank account rather than paying off your creditors themselves. In this case, you'll want to use the loan funds to pay your creditors as soon as possible to avoid additional interest charges on your old debts.
Once your new loan is set up, make consistent on-time payments to help build a strong payment history.
What if Your Loan Application Gets Denied?
There are many reasons why loans get denied. If a lender denies your debt consolidation loan, you should receive an adverse action letter, usually by mail, within seven to 10 business days of the denial. You're also entitled by law to receive a free copy of your credit report, which can help you identify areas of improvement for your credit. Once you understand why your loan wasn't approved, you can determine your next steps.
1. Request a Lower Loan Amount
Lenders often deny loans because they believe the risk is too great for your requested amount. Run the numbers to see if a smaller loan could help you save money. If so, you may have higher odds of approval by lowering the borrowing amount on your loan application.
2. Consider an Alternative Lender
Some personal loan providers use data other than your credit information—like education, employment and other factors—to make loan approval decisions.
3. Consider a Debt Management Plan
If you can't manage all your debts, you may be able to lower your interest rates and monthly payments by working with a credit counseling organization. A credit counselor can help you create a debt management plan (DMP) to repay your debt. Once you agree to this plan, you will pay the credit counseling organization directly, and they will make your monthly payments according to the repayment plan.
There are several resources you can use to find a reputable credit counselor, including:
- National Foundation for Credit Counseling: This agency can help you connect with an accredited counselor.
- Financial Counseling Association of America: Schedule a free consultation with a certified credit counselor.
- U.S. Department of Justice: The government maintains a state-by-state list of approved credit counseling agencies.
- Federal Trade Commission: The FTC provides valuable information on choosing a credit counselor.
If you have poor credit and cannot get approved by a conventional lender, you may find luck with companies like these.
Save Time by Getting Prequalified With Several Lenders at Once
While you can save money and pay off debt sooner with a debt consolidation loan, loan shopping and prequalifying for multiple loan offers to compare the loans can be time-consuming. But using tools from Experian, you can submit information and receive prequalified offers from several Experian debt consolidation loan partners right away. In this way, you can streamline the process and compare offers side-by-side to find the best option.