Debt Consolidation vs Personal Loans: What’s the Difference?

To pay off high-interest debt, you can consider debt consolidation loans or personal loans. Find out how they differ. (iStock)

If you have high-interest debt, consider consolidating your debt so you can save on interest by making only one monthly payment.

A debt consolidation loan can be a solution, but it’s not for everyone. Here’s everything you need to know about debt consolidation and personal loans.

Learn more about debt consolidation and personal loans, and compare rates from multiple lenders on Credible.

What is the difference between a personal loan and a debt consolidation loan?

You may hear or read about debt consolidation loans as a separate product from personal loans, but the two are essentially the same. The main difference is that debt consolidation loans are specifically aimed at paying off existing debts and consolidating them, whereas personal loans can be used for a variety of purposes including paying off new debts.

personal loan

Personal loans offered by banks, credit unions, and online lenders are flexible and can be used to pay off high-interest debt or whatever you prefer. Take one out and you’ll get a lump sum payment of hundreds to tens of thousands of dollars or more upfront.

You then repay the loan over the agreed-upon period, plus interest and fees. Factors such as your credit score and income will determine whether you are approved and the interest rate your lender will offer. Most personal loans are unsecured, so you don’t have to give up your house, car, or other assets.

debt consolidation loan

A debt consolidation loan is a personal loan used to combine multiple debts into a single loan, ideally with a lower interest rate than you are paying for the debt you wish to consolidate.

Here’s how it works: Apply for a personal loan for the outstanding amount of existing debt. Once approved, use the funds to pay off your debt. Then you will eventually pay off the new loan over the agreed repayment period.

Debt consolidation loans tend to be unsecured and can be tens of thousands of dollars or more.

What are the benefits of a debt consolidation loan?

Debt consolidation loans have several advantages and are suitable when you have multiple high-interest debts, such as credit card balances.

• low interest rate — You can save thousands of dollars in interest if you can borrow at a lower interest rate than your current debt.
• Debt repayment made easy — Combining multiple debts into one loan can reduce the number of monthly payments and simplify the repayment process.
• can improve credibility — Debt consolidation loans can reduce your credit utilization (how much of your available credit are you using) and increase your credit score.
• Monthly payments may decrease — Splitting your payments over new, longer term loan terms can reduce your monthly payments and free up cash each month.

What are the disadvantages of a summary loan?

Debt consolidation loans also have the following potential drawbacks:

• Not the solution to your financial problems — If your overspending led to your original debt, a debt consolidation loan does not guarantee that you will never go into debt again.
• prepaid fee — Depending on the lender you choose, you may be required to pay upfront fees such as loan origination fees or prepayment penalties if you pay off the loan early.
• Possibility of higher rates — Unless you have good credit, you may have to settle for a higher interest rate than you would like. Still, new personal loan interest rates may be lower than credit card rates.
• Unpaid payments can lead to further problems — If you miss your debt consolidation loan payments, you may have to pay late fees and insufficient funds fees, which increases your borrowing costs. Late or late payments can also affect your credit score.

When Should You Not Choose a Debt Consolidation Loan?

Debt consolidation loans aren’t always a good idea. A large amount of high-interest debt, or if you don’t have the budget to pay your monthly payments on time, can do more harm than good. Also, it might not make sense if you can’t secure a loan at a lower interest rate than you are currently paying.

Additionally, a debt consolidation loan is not beneficial if you have bad spending habits and are unable or unwilling to change them. there is.

Will a debt consolidation loan hurt my credit score?

A debt consolidation loan can improve your credit in the long run, but it can also temporarily worsen it. When you apply for new credit, lenders are likely to take a hard scrutiny, which can drop your credit score by a few points.

Opening a new account, like a personal loan, can temporarily lower your credit score, so taking out a debt consolidation loan may lower it even further.

Luckily, making timely payments can help your credit score recover and eventually improve. In addition, debt consolidation loans may reduce credit utilization and improve credit.

How do I qualify for a debt consolidation loan?

Every lender has their own requirements for borrowers interested in debt consolidation loans. However, most lenders look at factors such as credit score, income, and debt-to-income ratio as indicators of the likelihood of repaying a loan.

Lenders usually prefer borrowers with good credit, but debt consolidation loans with low credit do exist. Keep in mind that these loans usually have higher interest rates, which can increase the overall cost of the loan. If your credit score is low or high, you may need to apply for a joint guarantor or provide collateral.

How do I choose the best debt consolidation loan?

Not all debt consolidation loans are created equal. That’s why it’s important to shop around to find the right option for your situation. Consider these factors when doing so.

• interest rate — The lower the interest rate you can lock in, the better. A good credit score can save you a lot of money in the long run with very good interest rates.
• loan amount — Some lenders offer higher loan amounts than others. Figure out how much you need to borrow to pay off your debt and look for potential lenders to lend you that amount. Avoid the temptation to borrow more than you need.
• repayment terms — If your goal is to reduce your monthly repayments, extending the repayment period is your best bet, but you may end up paying more interest over the life of the loan. Conversely, if you want to pay off your debt as soon as possible and save interest, look for shorter repayment terms. A shorter term reduces your total interest cost, but may mean more monthly payments.
• commission — Some lenders charge fees such as origination fees, late fees and prepayment penalties. Find out how much it will cost before you sign the dotted line.
• collateral — Most debt consolidation loans are unsecured and do not require collateral, but there are also secured loans. If you qualify for an unsecured loan, you do not have to risk your property or vehicle as collateral. However, if you are looking for a debt consolidation loan with low credit, you may need to secure collateral.

We recommend that you prequalify for a debt consolidation loan if the lender you find allows it. This makes it easy to compare options without hurting your credit.

Debt Consolidation Loan Options

If you decide a debt consolidation loan isn’t for you, here are other ways to manage your debt.

• debt snowball law — The snowball debt method is a DIY debt relief strategy that pays off the smallest debt first and then applies the previous payments to pay off the smallest debt. Continue this cycle to build a payment momentum, or “snowball,” until the debt is gone.
• debt avalanche law — The Debt Avalanche Act is also a DIY strategy, but with a focus on saving interest over time. In a debt avalanche, you pay off the highest interest rate debt first, then move on to the highest rate debt.
• balance transfer credit card — A balance transfer credit card allows you to transfer high-interest credit card debt to a 0% interest rate card for a limited time as long as you pay a transfer fee. After the referral period ends, you will have to pay off the remaining balance at the card’s standard interest rate, which can be higher. However, you typically need good or good credit to qualify for the 0% card.
• Home Equity Line of Credit (HELOC) — HELOC allows you to borrow money against the stock in your home. Similar to a credit card, you can borrow as much money as you like up to a set limit to pay off your debt. However, this method puts his home in jeopardy as his HELOC is protected.
• cash out refinancing — Cash Out Refinancing replaces your current mortgage with a new mortgage that is greater than your outstanding balance. You can consolidate your debts by deducting the difference. Again, using home equity to consolidate your debt turns unsecured debt into debt secured by your home. Consider all the pros and cons before taking this route.
• debt consolidation — Debt consolidation is when you or your company negotiate with a lender or creditor to pay you less than you owe. Using this method can lower your credit score.
• credit counseling — In credit counseling, work with your credit counselor to develop a debt management plan (DMP). A DMP can lower your credit card interest rates, but it can also hurt your credit.
• bankruptcy — Bankruptcy involves appearing in federal court, where debts can be discharged or restructured. After bankruptcy, it can take years for your credit to recover, so it should be your last resort for debt relief.

You can find the debt consolidation loan that’s right for you by comparing shopping on Credible.