Table of Contents
- What does debt consolidation mean?
- How does debt consolidation work?
- How do you get a debt consolidation loan?
- What are the pros and cons of debt consolidation?
- Does debt consolidation hurt your credit
- When can debt consolidation help your finances?
- What are alternatives to a debt consolidation loan?
- Is debt consolidation a good idea?
1. What does debt consolidation mean?
Debt consolidation is the process of combining two or more loan balances into a single loan. You can use the funds from your new debt consolidation loan to repay other debt.
A debt consolidation loan may help you to save money on interest by lowering the annual percentage rate (APR) you pay on your loans. It simplifies your budget with one regular monthly payment rather than multiple payments with different due dates.
2. How does debt consolidation work?
Debt consolidation works by combining several loan balances into one new loan that you use to pay off the others. A personal loan typically offers a fixed interest rate and a fixed repayment term. This can give you predictable monthly payments and a set maturity date when your loan will be paid off. It is one of several methods you might use to consolidate debt.
You might also consolidate debt with a credit card balance transfer. With this approach, you move debt from one or more credit cards, typically with a higher interest rate, to another credit card that offers a lower introductory or promotional rate. However, a credit card balance transfer might have an origination fee, a variable APR, and may be more expensive if you don’t pay off the debt within the promotional period.
In addition, because a credit card is a revolving loan, there is no fixed payoff date, and the minimum amount you pay each month can fluctuate.
3. How do you get a debt consolidation loan?
Here are the steps for seeking and obtaining a loan for debt consolidation.
- Know your financial needs: Your first step is to know how much debt you currently have, the terms of that debt, and how much you’d like to borrow. You will want to ensure that any new debt will fit into your budget.
- Research loan options: Take your time to evaluate your options, which may include personal loans, balance transfer cards, or other loan types. You can find many online sources to help you evaluate your options. At Discover® Personal Loans, we offer a calculator to help you estimate your monthly savings based on information about your existing debts.
- Compare offers: Some lenders let you see if you prequalify for a loan before you apply. By entering your information, you can get a sense of what your interest rate, fees, repayment term, and monthly payment might look like.
- Submit an application: To apply for a personal loan, you will need to provide the lender your personal details, your desired repayment term, the loan amount you’re seeking, and other financial information.
- Review the terms of the agreement and accept the loan: If you are approved, carefully review the terms of the agreement before signing to make sure you understand what you’re agreeing to and any fees that might be included.
- Receive the funds and pay your debts: Once you’ve reviewed and accepted your loan, you’ll get your funds. You can then use the money to pay off other balances. With a Discover personal loan, funds can be sent as soon as the next business day after your acceptance.
4. What are the pros and cons of debt consolidation?
Depending on your situation, debt consolidation may have many benefits but also some drawbacks. It is important to consider the overall impact when deciding whether to move forward.
Pros of debt consolidation
Debt consolidation may potentially improve how you manage your debt repayment in a few ways.
- Fixed interest rate: Some personal debt consolidation loans offer a fixed interest rate, so you can know the total lifetime cost of your loan. If you have good credit, you may even qualify for a lower rate than what you’re currently paying.
- Set date your loan will end: Your personal loan repayment term is fixed, so you’ll know exactly when you’ll finish paying off what you owe.
- Simplified monthly payment: Consolidating multiple balances with a single loan means you only have one payment each month. A fixed payment for a set number of months may help you plan your household budget for the duration of the loan.
- Faster payoff: In some cases, you may be able to pay off your existing debt more quickly with a consolidation loan. 89% of surveyed debt consolidation customers told us they expect to pay off existing debt sooner with a Discover personal loan.*
- May help improve your credit: A debt consolidation loan may even improve your credit score. For example, Discover personal loan debt consolidation customers in good standing experience a 15+ point increase, on average, in their FICO® Score after three months of responsible payment behavior.**
Cons of debt consolidation
Although there are some clear advantages to a debt consolidation loan, it’s also important to consider the potential drawbacks or hurdles.
- May require good credit: To receive lower interest rates, lenders may require you have a strong credit score. If your credit score is fair or poor, you might not be offered an interest rate for a debt consolidation loan that is lower than your existing rate(s).
- Possible fees: Some lenders charge origination fees, late fees, prepayment fees, and other costs.
- Requires a hard credit pull: Applying for a personal loan typically results in a hard credit pull on your credit reports, which may lower your credit score temporarily.
- Does not resolve overspending: If you don’t address your spending habits, a personal loan to consolidate credit card debt may create an opportunity for more overspending on those accounts.
5. Does debt consolidation hurt your credit?
Obtaining a debt consolidation loan might impact your credit score in a few ways, both good and bad.
Some of the impact may be temporary. With consistent on-time payments, though, a consolidation loan may help you build and maintain a positive credit history over time.
- Credit utilization rate: Paying off credit card balances with a personal loan could lower your utilization rate, which measures how much revolving credit you are using. A lower utilization rate may benefit your credit score.
- Credit mix: If you only have credit cards or other revolving loans, adding an installment loan like a personal loan may potentially help your credit score.
- Hard inquiry: To approve a new loan, lenders typically conduct a hard inquiry into your credit report. While a single hard inquiry does not significantly impact your credit score, multiple inquiries in a short period of time may have a negative impact.
- New credit account: A new credit account might lower the average age of your accounts, which may have a temporary negative impact on your credit.
6. When can debt consolidation help your finances?
The decision to consolidate debt is a personal one, but there are some situations where it may make more sense than others. Here are some specific scenarios where it may be a good idea.
- You have multiple high-interest balances
- You have a strong credit history
- You have multiple payments to keep track of
- Other debt repayment strategies are not helping your financial picture
- You have a plan to minimize additional debt in the future
If some or all these scenarios apply to you, you might find that a debt consolidation personal loan would help. 85% of surveyed customers said they saved money by consolidating debt with a Discover personal loan and nearly half said they saved an average of $428 per month.*
7. What are alternatives to a debt consolidation loan?
Depending on your situation, you may want to consider other options.
- A new budget to address debt: Adopting the right budgeting strategy for you may be one alternative. You might consider the debt snowball vs. debt avalanche method or “50-30-20” budget approach.
- Credit card balance transfer: A balance transfer card often offers an introductory low or 0% APR promotion for a set period. However, you may be charged a balance transfer fee, and any debt remaining after the promotional period ends might be subject to the card’s regular APR, which could be as high or higher than the debt you’re trying to pay off.
- Home equity loan: A home equity loan allows you to borrow by using the amount of equity you have in your home. Loan amounts are typically larger than for a personal loan, and Interest rates may be lower. Additional terms will apply so you will want to read the agreement carefully.
- Debt management plan: If you have too much debt to manage and a consolidation loan is out of reach, you may consider pursuing a debt management plan through a nonprofit credit counseling agency. A debt management plan may help you negotiate a lower interest rate and monthly payment.
8. Is debt consolidation a good idea?
A debt consolidation loan may help your finances by simplifying your monthly payments and saving you money on interest. It’s important to evaluate your financial position to decide if it is right for you. Here are a few factors to consider.
Your credit score
If your credit score is strong, you might qualify for an attractive interest rate that lowers your monthly payments and the overall cost of your loans. Discover Personal Loans has a feature that lets you check your rate with no impact to your credit score.
Your repayment terms
As you shop around and compare lenders, you may find you are offered loans with different interest rates, origination fees, and prepayment fees. You will want to closely compare offers and costs. At Discover Personal Loans, you can pick the repayment term from options offered to fit your budget, and there are no fees of any kind.
Your budget
With any new loan, it’s important to know that the new monthly payment fits comfortably into your budget.
Your lender’s quality of service
When comparing offers, you may also want to consider the level of customer service the lender provides. Our dedicated, U.S.-based loan specialists are here to help. And it may help to know that 95% of responding customers would recommend Discover Personal Loans to a friend. *** See for yourself by reading our reviews.†
To find out if a debt consolidation loan may be right for you, it’s important to do your research. Our debt consolidation calculator may help so that you can estimate how much you might be able to save.
