U.S. Household debt is on the rise. Some of it can be attributed to wages not growing at the same pace as inflation. However, there will always be Americans who need to take on extra debt to pay for an unexpected medical emergency, obtain a working car, pay for home repairs, or something else. Regardless of the economy.
Sometimes things can hit us all at once, while other times the smallest addition can make our life unaffordable. Oftentimes – dare I say it – we’re just careless. Been there, done that. More than once. For example, I once maxed out my credit cards on toys and other fun, then got hit with a major auto repair. Stupid transmission. But I digress.
Whatever the reason for going into debt, getting out of it can feel impossible. Fortunately, there are ways to get out from under this burden. One of the best debt relief options is consolidating with a personal loan.
What is Debt Consolidation?
As you’re probably aware, debt consolidation is the strategy of combining multiple debts into a single loan or credit card, with the primary goal of making it easier to pay what is owed. Potential benefits include better manageability, paying it off more quickly, saving money, and improved credit scores.
What Kind of Debt Can Be Consolidated?
One of the most common types of debt consolidation is credit card debt. However, many people also choose to consolidate student loans, personal loans, medical debt, payday loans, business loans, buy now pay later (BNPL) plans, and other unsecured debt. Auto loans, home mortgages, and other secured debt can be combined too, but it’s not as common.
Why Use a Personal Loan to Consolidate Debt
There are many benefits to using a personal loan to consolidate debt. One of the most attractive aspects of a personal loan is it typically comes with a fixed monthly payment and interest rate. Also, it’s an installment loan rather than a revolving line of credit. That means credit doesn’t get freed up as you pay the balance down, making it harder to reuse the paid debt.
Personal loans generally offer lower interest rates than credit cards, the ability to borrow money without collateral, long-term repayment periods, and qualifying without affecting your credit score – depending on which company you use.
Additionally, a personal loan can be obtained quickly. Sometimes on the same day. And your credit doesn’t have to be perfect. Most lenders are offering $1,000 to $50,000 loans. However, you can find some offering up to $100,000 or more.
As you can see, there are many advantages to using a personal loan to consolidate debt, but there are disadvantages too.
Disadvantages of a Personal Loan for Debt Consolidation
Depending on your situation, the minimum amount you’re required to pay each month could go up with a personal loan. That might not help if you’re already struggling to keep up with your monthly payments. The lender or lending platform could charge a high origination fee. A substantial upfront fee could cause you to acquire even more debt and that fee could add 10% or more to your total debt load.
Furthermore, there may be better options available to you. For example, if you own a home worth more than what you owe on the mortgage, a home equity loan, line of credit, or refinancing could be cheaper. That doesn’t necessarily make them better choices for you. But they could potentially lower your monthly payments and cost you less money. What’s best for you specifically will depend on your financial situation, habits, and needs.
Alternatives to a Personal Loan
There are many ways to consolidate debt. You must start with what’s available to you. Obviously. Then I recommend being honest with yourself about your money management skills and the likelihood you’ll accomplish your goals with each option. What is technically cheaper on paper and when achieved perfectly, could end up costing you more if it offers you the flexibility to access the paid debt as it becomes available. Or for another reason.
Here’s a list of popular personal loan alternatives along with some features and benefits of each:
Credit Card – This can be cheaper in the short term, especially when you combine them by taking advantage of a balance transfer or other promotional offer. You can extend the savings when you participate in credit card churning. But that can get complicated, and it usually requires exceptional credit.
HELOC – Offers a longer repayment period and may provide lower fixed and variable interest rates, flexible payments, and can be tax deductible. However, a home equity line of credit requires homeownership with some equity in the property, can take longer to receive, and may require closing costs, insurance, annual and other fees.
Home Equity Loan – Offers a longer repayment period, and may provide low fixed interest rates, a dependable monthly payment, and can be tax deductible. A home equity loan, or HEL, requires homeownership with plenty of equity, can take longer to receive, and may require closing costs, insurance, and other fees.
Cash Out Refinance Loan – Offers a longer repayment period, the lowest annual percentage rate (APR), and can be tax deductible. Refinancing into a new home mortgage loan and taking cash out requires a home with significant equity, can take much longer to receive, and may require closing costs, insurance, and other fees. Your interest rate and insurance costs could also increase.
How to Use a Personal Loan to Consolidate Debt
First, you’ll want to get an idea of the likelihood you’ll be approved. Many online lenders make that process easy by allowing you to get prequalified without affecting your credit score. They do this with a soft credit pull.
If you are offered a loan but don’t like the terms, you should consider contacting your local bank or credit union. If you have a great credit score, you should have decent success by shopping around. Your options will be limited when your credit is fair, poor, or bad. In those cases, an online lender might be the only realistic choice.
Once you’re approved for a personal loan and have signed your loan documents, the funds will be sent to you via check or directly deposited into your bank account. The entire process can typically be done within 1 to 5 business days. Online lenders are usually the quickest from start to finish.
When your funds arrive you should begin paying off your other creditors immediately. You can pay them online, by phone, with a check, money order, in person, or otherwise.
What Happens After My Debts Are Paid Off?
Once your other debts are paid it might be smart to close those accounts. Whether you should or not depends on the type of accounts you are paying and your individual goals. If they are credit card accounts and you don’t want to be tempted to run them up again, closing them would be my recommendation. However, you might want to consider keeping one open for emergencies.
Just keep in mind your credit score could take a small hit initially. This will likely happen as soon as your new personal loan is reported to the credit bureaus, and again when you close certain accounts. It could also go up. It all depends on your overall credit situation, the type of accounts you are closing, and their status on your credit report.
If you maintain healthy credit habits going forward, your credit score should rebound quickly. Hopefully, faster than you expect, and higher than before you began consolidating. Just be sure to make your payment on time – it’s one of the most important things you can do!
Final Thoughts on Using Personal Loans for Consolidating Debt
In addition to using a personal loan to pay for expensive services and buy large things, a personal loan can be a smart tool for consolidating your debts. Personal loans typically have a lower interest rate and are less expensive than credit cards over the long run. They also make it easier to manage your debt in one place and rarely come with a variable interest rate.
Just be careful if you’re in the process of buying something large like a home or a car, as this fresh credit account could temporarily reduce your credit score. That is until you get everything combined and make a few on-time payments. If all goes as planned, you should begin to feel some relief and be looking at better credit and financial offers in no time!
Should you consolidate debt with a personal loan? That’s up to you. Hopefully, I’ve provided enough pros and cons to help you decide what is right. Otherwise, feel free to send me a message with your questions.