Debt consolidation is taking out one loan to pay off many debts. It’s a common get-out-of-trouble solution for consumers, especially those with overwhelming credit card debt. It simplifies bill-paying and, if done correctly, should reduce monthly payments.
The problem is that interest rates on debt consolidation loans vary wildly, ranging from as low as 5% to as high as 36%. Consumers using debt consolidation loans to pay off credit cards say they pay an average of 20% interest on those cards.
Whatever method you choose in consolidating your debt needs to include an interest rate that is half, or less, of that.
So how do you get that down to a single-digit interest rate that helps you pay off debt faster?
Improve your credit score!
Improving your credit score also could make you eligible for a zero-percent interest balance transfer credit card. Generally speaking, you would need a credit score above 700 to qualify for one of these cards.
How to Get a 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 all your debts. Now you are dealing with just one lender.
Although you might have an established relationship with your bank, it pays to shop around and get at least three quotes for comparison purposes. Credit unions often have better interest rates than national banks because of a cooperative structure that prioritizes the needs of its members. When scrutinizing online lenders, stick to reputable sites.
Before selecting your best loan option, check your credit report to make sure everything is accurate. Any mistakes on your credit report will result in a higher interest rate on your loan.
Also, consider improving your credit score because even a slight variance can save significant money. Make sure you receive a simple interest loan rate from a lending institution, instead of a variable interest rate that comes with a credit card and adds 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 number and proof of income, either through 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.
Below is a sample of the rates you can expect for debt consolidation loans at a bank, credit union, and online.
This is based on a $10,000 debt consolidation loan, with a 5-year term.
$11,951.62 total repayment
$12,822.16 total repayment
$15,779.71 total repayment
$11,877.89 total repayment
$12,469.58 total repayment
$15,162.71 total repayment
$11,820 total repayment
$12,580 total repayment
$14,794.69 total repayment
Steps to Improve Credit Score
The best borrowing rates 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 mean 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 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.