Debt Consolidation Loans

If high-interest credit card bills are pulling you down, consider a debt consolidation loan or InCharge's loan alternative to merge your debts and avoid a mountain of interest payments. But before applying, you need to understand how consolidation loans work to decide if one is right for you.

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About Consolidating Your Debt With A Loan

If you have trouble making ends meet, if your stack of monthly bills is covering every inch of the kitchen table, if the money coming in doesn’t come close to the money going out, it would seem like you’ve officially reached the end of your financial rope.

Now some good news: You really haven’t. There’s hope. Your solution could be a debt consolidation loan.

Even if you believe your money situation already has plunged into the abyss, look a little deeper. There are all types of debt consolidation loans, even if you have bad credit.

Sometimes, it’s reckless spending. Sometimes, it’s an unexpected life event, such as a major medical crisis or a bad divorce. Even people who practice financial responsibility can find themselves backed into a corner.

In those dire situations, the ability to consolidate debt can be a life-saver.

What Is a Debt Consolidation Loan?

Debt consolidation is a form of refinancing that makes it faster and easier to pay off what you owe. If you have multiple credit cards and carry balances on all of them, for example, you can take out a loan large enough to pay them all off, leaving you with just one payment a month. The loan you get typically charges less interest than the credit cards, making it easier to pay off.

It’s a great concept, but not as simple as it sounds.

Anyone who lends you money to consolidate your debt wants assurances you will pay back what you borrowed. The consolidation lender will check your credit and might ask for collateral. If you own a house and use a second mortgage or home equity line of credit (HELOC) to consolidate your credit card debt, you could risk losing your home if you find you can’t make the payments.

For that reason, most people apply for a personal loan to settle credit card debt, but a personal loan doesn’t work like a credit card. It  asks you to follow a strict repayment plan, which probably requires you to pay more each month than the minimum monthly payments you made on credit cards. Again, understand the terms before you leap into a personal loan.

How Does a Debt Consolidation Loan Work?

A debt consolidation loan should have a lower interest rate than credit card debt — sometimes as much as 10%-12% lower — so the amount you spend each month on interest should go down. On the flip side, personal loans come with fixed repayment schedules that amortize your debt over several years. For that reason, your monthly debt payment cost could easily increase.

If you can afford a larger payment, this can be a good thing. Paying off your debts on an installment plan will eliminate your debt rather than defer it. Minimum monthly credit card payments simply kick the debt can down the road; a debt consolidation loan will make it go away – assuming you control your spending and don’t rack up more credit card debt while paying off the loan.

Keeping track of multiple payments to multiple creditors can be a difficult. A consolidation loan simplifies the process, converting multiple bills into a single monthly payment.

It almost seems too good to be true, particularly if you get a favorable interest rate, so it’s an option well worth investigating.

Debt Consolidation Loan Rates

The average interest rate on debt consolidation loan was 11.88% in summer 2020, though rates vary widely, from as low as 6% to as much as 36%. As a rule, the higher your credit score, the better chance you’ll have of getting a low interest debt consolidation loan.

By contrast, with a credit score in the high 600s, your credit card interest rate could be in the 25%-36% range.

Though your credit score is the most important factor in setting your consolidation loan interest rate, lenders also look at variables that include your income and other debts you might be paying.

Pros & Cons of Debt Consolidation Loans

Debt consolidation loans can be a lifesaver for those who can afford the monthly payments. Though you might spend more of your income on debt once you’ve consolidated, a well-structured loan that fits your budget could offer a path to solvency. As with most things, deciding whether to take a consolidation loan to replace multiple credit card payments has both advantages and disadvantages.

Advantages to Debt Consolidation:

  • A single lump sum: A consolidation loan replaces several credit card bills with a single debt, one that is amortized over a fixed amount of time at a fixed interest rate.
  • Might save money: If you roll high-interest credit card debt into a consolidation loan with a much lower rate, you will save money on interest. This is true even if you have a higher monthly payment since you’ll be paying off principal. It’s important to understand the loan terms. The lower the interest rate and the longer the payment period, the less you pay each month.
  • Simpler finances: If you focus on paying off the consolidation loan, you will have a single monthly debt payment rather than multiple credit card bills. Better still, the interest rate will be fixed. Credit cards have variable rates, which means the card issuer can increase your interest rate and your minimum monthly payment, even if you stop using the card.

Disadvantages to Debt Consolidation:

  • Higher monthly payments: This is a new loan with new terms. You will use the proceeds from the loan to pay off your credit cards, but loans have different terms than credit cards. It will amortize your debt over a fixed amount of time, say three to five years, and the amount of each payment might exceed the combined amount you had to send out to cover your cards’ minimum monthly payments.
  • Risk of growing debt: If you had a hard time managing your credit and you continue to use your credit cards, you could end up with more debt than you originally had. The best strategy is to pay off credit card balances each month while focusing on paying down your consolidation loan.
  • Poor credit: If you have a poor credit score, one that falls below 620, a debt consolidation loan might be difficult to obtain. Even if you can find a lender, the interest rate might be higher than what you’re paying on your credit cards. Before looking for a loan, try making all credit card payments on time in an effort to raise your score.

» More About: Pros and Cons of Debt Consolidation

Do Debt Consolidation Loans Hurt Your Credit?

The nation’s three credit rating bureaus typically will raise your score if you demonstrate your creditworthiness by making required payments on time each month. You could damage your credit score if you fail to stay current on your loan payments or you add fresh balances on your credit cards while repaying the consolidation loan.

How to Get a Debt Consolidation Loan

Taking stress out of your financial life seems like a great idea. Reducing monthly payments to a single source sounds good to almost anyone in financial distress.

But be careful. It works only if the debt consolidation loan reduces the interest rate for your debts, in addition to cutting back the amount you pay each month. So, it’s important to be organized and have precise financial records.

Here are some steps to follow when you’re studying whether to get a debt consolidation loan:

  • Make a list of the debts you want to consolidate.
  • Write down the amount owed in one column, the monthly payment due in another and the interest rate paid in the last column.
  • Now add the total amount owed on all debts. Put that figure at the bottom of column one. That’s how much you need to borrow for a debt consolidation loan.
  • For comparison purposes, add the monthly payments you currently make for each debt. Put that number in the second column.
  • Go to a bank, credit union or online lender to ask for a debt consolidation loan (occasionally referred to as a personal loan) to cover the total amount owed. Ask about the monthly payment figure and the interest rate charges.
  • Do a comparison between what you’re currently paying each month and what you would pay with a debt consolidation loan.

Bottom line: Your new monthly payment and interest rate should be lower than the total you are currently paying. If it’s not, you could negotiate with the lender to lower both rates. Usually, banks and credit unions recognize good customers and will work to reduce those rates.

Debt Consolidation Loan Requirements

Though a debt consolidation loan has advantages, it might not be right for you. Before applying, review eligibility requirements. These include

  • Age: You need to have reached the age of majority to borrow money in your own name. In the U.S., which is generally 18.
  • Residence: Lenders usually require that you live in the United States.
  • Financial history: If you have a recent foreclosure or bankruptcy on your record, it will probably have damaged your credit rating and made you unlikely to qualify for a loan.
  • Subpar income: Lenders usually want loan candidates with a steady job. You should have documentation like pay stubs to show you have a regular income.
  • Financial stability: You might need to demonstrate that you are responsible with money and have a stable lifestyle. That means offering evidence that you have lived in one place for a while and that you monthly debt payments don’t exceed 36% of your income.

Debt Consolidation Loan Example

It’s hard to compare situations because every debt scenario has different layers and complications, but here’s an example of how a debt consolidation loan could work.

Imagine you owe $5,000 on a credit card with an interest rate (APR) of 18.9% and you are paying $200 a month toward the debt.

You also owe $2,000 a month on a credit card with a 15.9% APR and pay $150 a month on that one.

Now it’s starting to mount. You owe $15,000 on a car loan with a 6.5% APR. You are paying $355 a month for that

There’s also a $5,000 debt on the braces for your 12-year-old son. His smile is well worth the 9.0% APR, which means you are paying $150 per month.

Your total debt: $27,000. The average of all those interest rates is 9.96%. You are paying $855 a month.

By continuing to attack those bills separately, it would require 40 months to pay them off. You would pay $4,722 in interest.

Now imagine getting a debt consolidation loan for $27,000 with an interest rate of 6.99% It would take you 38 months to pay it off. You would pay $3,128 in interest.

Under this scenario, the debt consolidation loan would save you $1,594.

Who wouldn’t want that? But remember that hypothetical 6.99% interest rate? That’s a rate that is given to low-risk borrowers. So that brings up the benefit of a good credit score.

The average APR on a personal loan in August 2020 was 9.63%, according to the Federal Reserve. The average credit score was 685. To receive our hypothetical 6.99% APR, your credit score would need to range somewhere in the mid-to-high 700s.

These figures are not absolute by any means. Lending options exist everywhere. Some work better than others. To avoid confusion — while helping with the number-crunching and arriving at a spot where you’ll actually save money — it’s helpful to contact a nonprofit credit counseling agency for advice.

Types of Debt Consolidation Loans

Not all debt consolidation loans are created alike. There are differences between secured and unsecured loans, so it’s important to understand and consider the various options.

Unsecured Personal Loan

Having a lending institution or person hand you a chunk of money with no collateral required is a relatively low-risk way to consolidate debt, but it has pitfalls. Many banks, credit unions and online lenders offer these loans.

Credit unions are a good place to start shopping for a personal loan since they usually offer the lowest interest rates, though banks and online lenders also offer competitive rates and repayment terms. If you have a friend or family member willing to make a loan, consider that option as well.

Unsecured loans usually come with fixed interest rates and monthly payment periods, but you need excellent credit to get the best rates and usually must pay an origination fee. Interest rates vary widely and sometimes are higher than what you’re paying on your credit cards.

Bottom line: Unsecured personal loans are a good way to consolidate debt, but you should shop around before accepting one.

Secured Loan

These are loans that require collateral. You pledge to pay off the loan, and if you don’t make payments, the lender can take the asset.

With a mortgage, a finance company or bank will hold the deed or title until the loan has been paid in full, including interest and applicable fees. Assets such as personal property, stocks and bonds are sometimes accepted as collateral.

It’s obviously preferable not to risk your house or car, but that is often the only way to avoid paying high interest rates. Secured loans usually offer lower interest rates and longer repayment periods than unsecured ones. If you have substantial equity in your home, you can borrow against it (see below) though a HELOC, second mortgage or cash-out refinancing. Only consider this if you have a steady income and a strong prospect for paying down the loans.

401(k) Loan

These are loans from employer-sponsored retirement accounts. You know, the money automatically withdrawn from your paycheck that your employer contributes to.

It’s a great way to prepare for your golden years. Messing with it is a great way to have a lower standard of living in retirement years.


You’re forfeiting potential gains from your investments in the stock market. The borrowed funds are taxed twice. You’re contributing less to your retirement plan because a portion of new contributions goes toward paying off the loan.

The loans are usually for five years, but if you cease working the remaining amount is due in 60 days. If you can’t repay it, you pay tax on the outstanding amount and incur a 10% early withdrawal penalty until you reach age 59½.

On the plus side, the loans are easy to get since you are borrowing your own money. That’s assuming your employer allows borrowing from your 401(k), and some don’t.

And the interest rates are far cheaper than what credit cards charge. The loan also won’t show up on your credit report, so defaulting won’t affect your credit score.

But considering all the risks and penalties, it’s best to look at a 401(k) loan as a last resort.

Balance Transfer Loan

You take your current credit card balances and transfer them to a new credit card, one with zero or a low introductory interest rate, but this is only for consumers with good-to-excellent credit scores. You will save money in the short term and consolidate the balance, but there are pitfalls. There’s a balance transfer fee (usually from 1% to 5%). Be careful of continuing to use the original credit cards (if they aren’t closed out). And the No. 1 pitfall … READ THE FINE PRINT. The introductory interest rate (maybe 0%) will generally expire in 12-18 months. After that, the rates escalate to levels even higher than the original credit card rate. For example, if you’re paying 24.99% APR on $10,000 in credit card debt, that will cost you a whopping $12,495 in interest over five years.

Home Equity Loan

You take out a loan against your home and use the money to pay off your credit card debt. Equity is the amount your home is worth minus the amount you owe on mortgage (Example: home valued at $200,000 minus $100,000 remaining on the mortgage equals $100,000 in home equity). Remember that a home equity loan is secured by … your home! So, if you can’t make the payments, you could lose your home. Be careful! Also pay close attention to the repayment schedule. If an $800 monthly credit-card loan payment becomes a $500 home-equity loan payment, look a little closer. There are sometimes 15-year or 30-year repayment schedules when using a home equity loan for debt consolidation, so in the long term, you could be paying a lot more than the original debt.

No New Loan

This is better known as a debt management program. You could get many of the benefits of debt consolidation without the risks through nonprofit credit counseling agencies. Counselors, like those at InCharge Debt Solutions can find the plan best for you and the best solution, which could be a debt management program, bankruptcy or a referral to other agencies that can help with your situation.

Debt Consolidation Loan Companies and Costs

There’s more than the interest rate to consider when seeking a debt consolidation loan. There are closing fees, service fees, pay-off dates and other “fine-print’’ charges. Here are the three primary options for where to get a debt consolidation loan. Remember, as with all lending institutions, the rates will vary.

  • Credit Unions: The country’s largest credit union is Navy Federal. In July 2020, its lowest APRs went from 7.49% for a 36-month loan to a low of 14.79% for loans of as long as 60 months.
  • Banks: Wells Fargo is typical, offering loan amounts from $3,000 to $100,000. The APR, of course, depends on your creditworthiness. Typical rates in the summer of 2020 ranged from 5.24% to 20.24% for payment periods of 12 to 84 months.
  • Online Lenders: APRs range from low single digits to 36%. Payoff, an online lender that exclusively offers credit consolidation loans, typically charges an APRs from 6% to 25% with loan amounts ranging from $5,000 to $35,000. It has origination fees that range from nothing to 5% of the loan amount. To qualify, you need of credit score of at least 640.

There’s also an online debt consolidation option called “peer-to-peer lending,’’ where companies allow investors to lend directly to consumers. Lending Club offers loans up to $40,000 and charges borrowers an origination fee of 1% to 5%, depending on the credit risk. Rates are based on your financial situation, but in July 2020 the website reported APRs ranging from 6.95% to 35.89% for loans with terms of three to five years.

Whatever option you consider, shop for the best deal. You loan should cover the money you need to consolidate your debts at an affordable cost and a workable repayment period. Try to get a loan with low or no fees, which the more money you save on origination costs in money you can apply to paying off what you owe.

Alternatives to Debt Consolidation Loans

If you evaluate your finances and conclude that you can’t manage repayment of a debt consolidation loan without destroying you budget, you probably should consider other debt consolidation programs and alternatives. Here are a few:

  • Debt Relief – This is a catch-all for programs that can ease your debt load if you find you can no longer manage. Alternatives include negotiating with your creditors on your own, seeking advice from a nonprofit credit counselor and consulting with a debt management firm.
  • Credit Counseling – This is one avenue to debt relief. A nonprofit credit counselor like InCharge Debt Solutions will assess your debt load and your income and suggest solutions, which might include a debt management plan.
  • Bankruptcy – This is the most extreme form of debt relief. You must petition a court to enter bankruptcy and create a plan for exiting it. This might include repaying some of your debts or eliminating almost all of them. Bankruptcy can severely damage your credit report and make it difficult to borrow money for years. Some debts, including student loans, can’t be cleared through bankruptcy.
  • Debt Management Plan – Nonprofit debt management firms like InCharge will create a plan for paying off debt. This usually involves working with creditors to lower your interest rates or stretch out payments. The goal is getting creditors to accept a plan that meets your budget. The debt manager will consolidate your credit card debt into one monthly payment that you make to the management company for distribution. The process usually takes three to five years.
  • Debt Settlement – You can contact your creditors to propose a settlement. If successful, you will be allowed to pay less than what you owe. Typically, you need to demonstrate a financial hardship like a job loss or a medical condition that prevents you from paying off your debts fully. Debtors often use debt settlement companies to negotiate for them. Under managed debt settlement, you would pay monthly amounts into a savings account and the debt settlor would use the money to satisfy terms of the settlement. Debt settlement has disadvantages. Since it discharges debt, it can damage your credit score, but it might stave off bankruptcy. Debt settlement also might not work if your creditors refuse to negotiate or reach an agreement.

Is a Debt Consolidation Loan Right for You?

Remember that debt consolidations loans solve what might be a symptom of chronic money-management problems. When that stack of bills suddenly goes away, it could bring a false sense of security. The real issue is solving the spending patterns that got you in the financial hole. Debt consolidation loans can be useful tools, but they aren’t the be-all, end-all solution.

Before applying for a consolidation loan, check you credit score and reports, which are very important tools that lenders use to decide whether to offer you a loan and at what interest rate. Then assess how much you can afford to pay each month. If your consolidation loan payments paired with your other expenses use all your income, getting one might not be the wisest way to go. Be honest with yourself and don’t take on a loan that could leave you worse off than you are.

If you are uncertain about your options or simply want more information, contact a nonprofit credit counselor like InCharge for advice. Credit counseling can help you explore your options and discover the best way to consolidate your debts.

About The Author

Joey Johnston

Joey Johnston has more than 30 years of experience as a journalist with the Tampa Tribune and St. Petersburg Times. He has won a dozen national writing awards and his work has appeared in the New York Times, Washington Post, Sports Illustrated and People Magazine. He started writing for InCharge Debt Solutions in 2016.


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