If you have a lot of high-interest debt, getting a debt consolidation loan may be a smart move. You can use the loan proceeds to pay off high-interest debt, leaving you with one loan.
Consolidating your debt can help you manage your finances, but it’s crucial to understand how it will affect your credit. Read on to learn how to find the best debt consolidation loan for your situation.
Debt consolidation is a process in which you roll your various debts into one loan, leaving you with one monthly payment. A debt consolidation loan can be a helpful tool in managing your finances.
If your debt has become overwhelming, consolidating what you owe into one loan will simplify your payments. Other potential benefits include lower monthly payments, less interest paid overall, and faster debt clearing.
You can consolidate debt in several ways, including:
If you’ve decided that a debt consolidation loan is for you, it’s important to find one that’s the right fit.
Factors to consider when looking at different debt consolidation lenders include:
Related: Learn more about getting a personal loan
Debt consolidation may make sense if your credit profile is robust. If you have good credit, the chances are higher of you qualifying for a debt consolidation loan with a competitive interest rate, or a balance transfer card with a 0% introductory APR..
Otherwise, the interest savings may not merit taking out the loan if you can’t qualify for a much lower rate.
If your monthly expenses (including rent or mortgage) don’t exceed 50% of your income, a debt consolidation loan may make sense. That’s because debt consolidation lenders want to see that you can afford to make on-time payments before approving a loan application.
You’ll also want to have a sound plan to pay off your debt — say, in five years or so — when consolidating your loans. If you don’t have a plan to pay everything off, you could dig yourself further into debt. In this case, it would defeat the purpose of why you’re trying to consolidate your debt in the first place.
A debt consolidation loan may not work for you if you don’t have good credit, since you probably won’t qualify for a competitive interest rate and favorable terms. Both of these factors can increase the costs of borrowing and could stretch your budget too thin.
Even if you have good credit, if your existing debts aren’t significant, consolidating may not be the best move. Specifically, if you can pay off what you owe in under a year, you may not be able to save as much on interest. Plus, it may not be worth spending the time and effort to compare and apply for a loan.
Each time you apply for a loan, lenders will conduct a hard inquiry to look at your credit report. This could negatively impact your credit score for a couple of years.
One of the major factors to consider when taking out a consolidation loan is how your payment history will affect your credit score. If you make payments on time, it could boost your credit score. However, even one late payment could have a negative impact.
If you’re using a debt consolidation loan to pay off your credit card debt, it could lower your credit utilization — the percentage of how much available credit you’re using in your revolving accounts — helping to raise your score. However, if you’re using a balance transfer credit card, it may not make much of a difference.
Related: Learn more about getting a personal loan