Credit scores range from 350 on the low end to 850 on the high end and it’s extremely helpful to know your score. There are several credit card companies, online websites and banks that will give you a free credit score, so find one and see where you stand. You should understand that the “free score” you receive is a ballpark figure, not the identical number that the lender will receive. However, it should be close enough to let you know whether you fall in the excellent, good, fair or poor category that determines your final interest rate.
Having collateral to secure the loan will improve your standing, regardless of what category your credit score puts you. Lenders believe that the threat of losing the home or car you put up as collateral is enough to encourage you to make your debt consolidation loan payment every month. Lenders will give you a better rate because they have something to fall back on.
How to Get a Low-Interest Debt Consolidation Loan
The cleanest route to a debt consolidation loan is through a bank or lending institution, such as a credit union or online lender. You simply borrow enough to pay off multiple debts and now you are dealing with just one lender.
Although you might have an established relationship with your bank, it pays to shop around for the best interest rate and get at least three quotes for comparison purposes. Credit unions often have better rates than national banks because of a cooperative structure that prioritizes the needs of its members.
When scrutinizing online lenders, stick to reputable sites and read the fine print about the amount of interest you’ll pay.
Before selecting your best loan option, check your credit report to make sure everything is accurate. Any mistakes on your credit report will have a negative impact on your credit score and result in a higher interest rate on your loan.
Also, take steps to improve your credit score. Even a slight variance upward can save significant money. Make sure you receive a fixed-interest loan and not a variable interest rate that could add to the total cost of the loan.
When you are satisfied with your credit report and credit score, make an appointment with the lender. Specify the amount of money you’d like to borrow. The lender might ask what you will do with the funds.
While filling out the application, you should bring identification, proof of address, your Social Security card and proof of income, either pay stubs or tax returns.
The lender will advise you of the likely timetable and begin the underwriting process, which evaluates you as a potential borrower. Your credit history and financial stability will be examined. For larger loans, the lender might inquire about potential collateral.
Make sure you know about any fees attached to the loan, such as an early termination fee or initiation fee. Additional fees could erase the savings from what seems like a favorable interest rate.
Once you get the loan, make certain you understand the terms and be sure to make your payments on time.
Examples of Debt Consolidation Loan Interest Rates
Below is a sample of what you can expect for debt consolidation loan interest rates at a bank, credit union, and online lender in the summer of 2019. Rates at your lending institution may vary.
This is based on a $10,000 debt consolidation loan, with a 5-year term.
| BANK |
|
Good Credit
(above 720):
|
7.25%
interest rate
|
$199.19
monthly payment
|
$11,951.62 total repayment
($10,000 principal plus $1,951.62 total interest over life of loan)
|
|
Average Credit
(660-720):
|
10.25%
interest rate
|
$213.70
monthly payment
|
$12,822.16 total repayment
($10,000 principal plus $2,822.16 total interest over life of loan)
|
|
Bad Credit
(under 660):
|
19.65%
interest rate
|
$263.00
monthly payment
|
$15,779.71 total repayment
($10,000 principal plus $5,779.71 total interest over life of loan)
|
| CREDIT UNION |
|
Good Credit
(above 720):
|
6.99%
interest rate
|
$197.96
monthly payment
|
$11,877.89 total repayment
($10,000 principal plus $1,877.89 total interest over life of loan)
|
|
Average Credit
(660-720):
|
9.050%
interest rate
|
$207.83
monthly payment
|
$12,469.58 total repayment
($10,000 principal plus $2,469.58 total interest over life of loan)
|
|
Bad Credit
(under 660):
|
17.775%
interest rate
|
$252.71
monthly payment
|
$15,162.71 total repayment
($10,000 principal plus $5,162.71 total interest over life of loan)
|
| ONLINE LENDER |
|
Good Credit
(above 720):
|
6.89%
interest rate
|
$197.00
monthly payment
|
$11,820 total repayment
($10,000 principal plus $1,820 total interest over life of loan)
|
|
Average Credit
(660-720):
|
9.428%
interest rate
|
$209.67
monthly payment
|
$12,580 total repayment
($10,000 principal plus $2,580 total interest over life of loan)
|
|
Bad Credit
(under 660):
|
16.637%
interest rate
|
$246.58
monthly payment
|
$14,794.69 total repayment
($10,000 principal plus $4,794.69 total interest over life of loan)
|
Improving Your Credit Score for a Lower Interest Rate
The best interest rates for debt consolidation loans go to consumers with credit scores 740 or higher. The further down the scale you go, the higher the interest rate you will pay. Anything below 660 is going to result in a high rate, though maybe not as high as the rate for credit cards.
The steps to get a better credit score are manageable, but require discipline.
- Pay bills on time
- When possible, pay off your balance every month, or at least make minimum payment
- Set up automatic payments to make sure you don’t miss one
- Keep credit card balances at less than 30% of your credit limit
- Don’t sign up for new credit cards
- Look for mistakes on your credit report
This won’t be easy, but if done effectively, it will raise your credit score and lower the interest rate you pay on a consolidation loan.
Best Ways to Consolidate Debt
There are four major ways to consolidate debt: bank loan; credit card balance transfer; debt management program and personal loan.
Each one has positives and negatives associated with it, so examine them closely. It is important to know about fees or penalties for things like late payments, balance transfers or early pay offs.
Here are the highlights of the four options.
- Bank Loan —Relatively simple. You borrow enough from the bank to pay off all your debts and negotiate for an interest rate that will help reduce your monthly payments. Now you deal with one lender — the bank.
- 0% Interest Credit Card Balance Transfer — Many credit cards offer 0% interest for an introductory period of 12-18 months. It can be efficient to transfer your debt to a 0% card, but only if you pay off the balance before the introductory period expires. Qualifying for this card requires a very good credit score.
- Debt Management Program — Reach out to a reputable, nonprofit credit counseling agency about a debt management plan. The counseling agency works with creditors to reduce your interest rate and monthly payments. You make one monthly payment to the agency, which pays each of your lenders at an agreed upon rate. The debt management plan typically lasts 3-5 years. The key is consistency. By committing to the plan and not running up more debt, you can erase your problem.
- Personal Loan — You have a simple interest rate from a bank or credit union, instead of a variable interest rate that comes with a credit card. You could consider taking a personal loan from a family member or friend, who might give you a really low rate. But don’t take advantage of the situation. Treat it like any business transaction, keep perfect records and pay on time.
There is not a one-size-fits-all strategy here, but there is a universal truth. None of these plans will work if you can’t make your payments or if you string out the process to where you’re paying more in interest than you originally owed. Be smart. Know that the real way out of debt is to change your spending habits and develop a financial game plan where you don’t go beyond your current resources.
Understanding Interest Rates
You have undoubtedly heard the term “interest rate” a million times, but what does it mean in real terms?
Interest is money you pay for the privilege of borrowing. Let’s say a bank loans you $1,000 at a 6% annual interest rate. That means you’d pay an extra $60 if you pay back the $1,000 at the end of 12 months.
That’s called “simple interest.”
Most loans utilize “compound interest,” where you don’t just pay interest on the initial $1,000 loan, you also pay interest on the accumulated interest. The rate that debt grows depends on how often the loan “compounds,” or comes due. With credit cards, it’s typically once a month.
The bottom line: When you choose debt consolidation, shop around for the lowest interest rate possible.
Low/Zero Interest Rate Credit Cards for Loan Consolidation
When you see an offer of 0% interest, it sounds too good to be true, right? But that credit card option is out there — readily available, actually — and could work to your advantage with proper planning, if you qualify.
If you shop around, it’s easy to find a credit card company that offers 0% interest rate on the transfer of an existing credit card balance. These are generally introductory offers, so the interest rate changes, usually in 12-18 months. And that change might be ridiculously high!
By paying attention, however, you can pay down your debt while the rate is zero. Be sure to read the fine print on zero-percent balance transfers. There usually is a 1%-3% interest fee charged on the amount transferred.
Credit scores also come into play when applying for 0% credit cards. The average credit score accepted for major 0% cards ranges from 685 (Chase) to 707 (Discover) to 736 (Citi).
Home Equity Loans/Lines of Credit
This is basically a second mortgage. You put up your house as collateral and secure a loan or a line of credit. Interest rates are usually between 5% and 8% with the average rate for a $30,000 loan in 2019 hovering near 6%.
Interest Rates on 401(k) Loan
About 75% of the people with a 401k plan have the option of borrowing against the money in that plan to take care of financial emergencies.
You are borrowing money from your retirement account and repaying with part of your weekly paycheck. You can borrow 50% of the total in your 401k account or $50,000, whichever is smaller.
Interest rates are usually based on the Prime Rate plus 1 or 2%, so a five-year loan would have an interest rate in 2019 of about 6.5%. But the interest is repaid to the consumer’s own account, so it’s not a loss.
Interest Rates on Payday Loans
If the loan business were the weight-loss business, this would be like going to a diet clinic and being handed a bag of doughnuts.
A consumer borrows a small amount of money – usually less than $500 – and pays an extraordinarily high interest rate.
They typically write a post-dated check in the amount they wish to borrow, plus a finance charge. The lender holds onto the check and cashes it on the agreed date, which is usually the consumer’s next payday.
Most loans are due in two weeks, and research shows 70% of borrowers take out a second payday loan before paying off the first. The finance charge for most payday loans is $15 per $100 borrowed for two weeks. That’s translates to an annual interest rate of 399%.
Repeat – 399%!
A variation of the payday loan is the auto title loan, where the consumer puts up his or her car as collateral. If the borrower can’t repay the loan in 30 days – and studies show that 20% can’t – they lose their car.
Compare More Than Rates
If you’re comparing the various debt consolidation plans, be certain to investigate more than just the interest rate offered. Some loans carry an early termination fee, others have an initiation fee. These fees, sometimes not so obvious, might wipe out the savings you thought you were getting from a more favorable interest rate.
If you’re looking at 0% interest rate introductory credit card, make sure you can pay it off before the new card’s interest rates kick in or you might have an even bigger problem.
For personal loans, use your common sense. If you have bad credit, the interest rates can be outrageous, so be forewarned.
If your credit score is low (less than 600), you might have trouble qualifying for a loan. There’s always a home equity loan, where you borrow against your home. The risk: If you fail to make payments, you’ll be facing foreclosure.
There’s also a secured loan from a bank or credit union. You must put up a valuable item (such as a car) as collateral. The risk: If you fail to make payments, you’ll lose the collateral.
Before doing anything, it’s always useful to check your credit reports and scores, making sure everything is accurate. Credit reports and scores are the financial bible for lenders and a mistake could cost you thousands in interest rates.
If you consolidate into one credit card, avoid maxing out that card’s credit limit because that harms your credit utilization rate, which is how much debt you’re carrying compared to your total credit limit.
Also know that applying for a new line of credit creates a hard inquiry on your credit report. It can lower the average age of your credit history and thus lower your credit score. A new personal loan shows that you have a high level of outstanding debt.
But adding a personal loan also improves your mix of accounts. By keeping on top of payments, you establish a positive payment history, which should help your credit score.
Drawbacks to Debt Consolidation
There’s risk involved with any method you choose for debt consolidation so do your homework. Here is a look at some of the drawbacks for each plan.
- Debt Management Program —It always sounds good to take the payments from several credit cards (let’s say a total of $1,000 per month) and reduce it to one lower payment (let’s say, $800 per month). But be careful. Be sure the nonprofit credit counseling agency you choose has a good track record with consumers. They should present you with a plan that lowers your interest rate and monthly payment and eliminates all debt within 3-5 years. If that doesn’t happen, back away.
- New Lines of Credit/Second Mortgages —The major problem is that your home is used as collateral and if you miss payments, it could be foreclosed. The other thing to look for is fees for anything and everything the lender can think of. Make them spell out if you’re paying an origination fee, appraisal or any other cost.
- 0% Interest Rate Credit Cards —The risk is not paying off the debt during the introductory 0% interest rate period (usually 12-18 months). When that period is over, you could be facing interest rates of 18% or higher. You must be disciplined.
- Personal Loans — Depends on who loans you the money. If it’s a relative or friend, the relationship can sour quickly if you fail to make on-time payments and/or default on the loan. If you get it from a bank or credit union, you will pay a higher interest rate because it’s an unsecured loan, meaning no collateral to back it up.
Personal Loans vs. Debt Consolidation Loans
It’s easy to get confused when considering whether to take out a personal loan or seek a debt consolidation loan.
There are subtle differences.
A personal loan can be used for any expense. It’s granted based on your credit worthiness. With a secured personal loan, there is collateral needed (such as your home or car).
According to Farmers Bank, for a $5,000 unsecured loan with a two-year term, consumers will receive an 11.25% annual percentage rate (or a $224 monthly payment).
According to Bankrate, for a $10,000 secured loan with a three-year term, consumers with excellent to good credit can receive a 4.29% APR or an approximate $297 monthly payment. With fair credit, it shoots up to 10.66% APR, or a $326 monthly payment. With poor credit, if the consumer is still being considered, it hits 25% APR (or a $398 monthly payment).
You could take out a higher loan than needed in order to cover new expenses. Personal loans are high risk, so they will be at a high cost. But when paid in full, they will significantly boost your credit score. There is no consolidation company working on your behalf, so the consumer must have the discipline to use the funds for the debt and not for some other whim that might come along.
A debt consolidation loan is used specifically to pay down your debt. You’re usually working with a consolidation company that uses its experience and contacts to reduce the interest and monthly payment so you can efficiently settle your debt.
It might come with protections from previous lenders, who won’t be able to contact you once the debt consolidation company has taken over. It will have a high interest rate because it’s a high-risk loan. You are surrendering your flexibility in exchange for total control by the lender.
There are a lot of loan options out there. Don’t choose one that will leave you worse off than you began. Get at least three proposals from banks or other lending institutions. If the best offer you can find is a payday loan, don’t eat the doughnuts. Instead of a loan, you probably need to completely overhaul your financial life.
That is why it’s wise to get a proposal from a nonprofit credit counseling agency like InCharge. Certified counselors can advise you on an overall strategy to get out of debt forever.
Sources
DiGangi, C., (2017, 10 March), 5 Tips for Consolidating Credit Card Debt. Retrieved from https://www.credit.com/debt/5-tips-for-consolidating-credit-card-debt/
Ramsey, D., (2017), The Truth About Debt Consolidation. Retrieved from https://www.daveramsey.com/blog/debt-consolidation-truth
Chough, V., (2017, 6 February), How To Get The Best Debt Consolidation Loan Rates. Retrieved from https://www.credible.com/blog/how-to-get-the-best-debt-consolidation-loan-rates/
NA, (2008, 6 March), How To Get A Low Interest Rate Debt Consolidation Loan. Retrieved from https://www.sapling.com/4589352/interest-rate-debt-consolidation-loan
