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What is a Debt Consolidation Loan [2020 Changes]

Dan Steadman

Financial Advisor, MoneyBeagle

What is a Debt Consolidation Loan?

Household debt in the United States has reached record heights. Total household debt climbed to $12.73 trillion as early as the end of first quarter of 2017. This, for the record, is $50 billion higher than the worse marks reached during the 2008 financial crisis, according to a report by the Center for Microeconomic Data. Now that the US economy is starting to recuperate, Americans are slowly but surely gaining access to more credit once again.

As Americans currently enjoy this sense of freedom, however, household debt is skyrocketing and not showing signs of slowing down anytime soon. This creates obvious problems for the economy, irresponsible lending and borrowing are what began the financial crisis back in 2007. But on a more micro level, a large amount of debt has a profoundly crippling impact on an individual and their ability to progress in life.

Introduction

Debt consolidation helps get people back on track – it’s a great way to alleviate the burdens of debt without doing serious damage to your credit score. The consolidation process involves paying off debt using finance and then repaying this finance at a much reduced rate than what was attached to your original debts. This page will give you all the tools you need to understand if debt consolidation is the right choice for you.

Why People Fall into Debt

The idea of borrowing money has always been an attractive option for most people. From cars, houses, consumer goods, and other items of luxury, consumers feel having these things are part of the “American Dream”. Lenders, on the other hand, have made it easier for anyone to live it.

Debt is a problem that is mainly symptomatic in modern culture. There have been numerous studies on how current financial products have helped increase the amount of debt that people undertake. For example, if you go to a restaurant and you have cash, you’re much less likely to spend more money than if you have a credit card. The psychology of not having the money directly in your hand (in the case of a credit card) makes it much more likely that you’ll spend bigger.

However, many of the reasons people fall into debt point to lack of skills in handling money. Most people never learned it in school anyway. Add that with a problematic mindset and lack of discipline, and you are on your way to being part of the latest debt statistic.

In some cases, debt is incurred by extraordinary events. Personal crises and unexpected expenses such as a medical emergency or unplanned house repairs can ruin one’s budget for the month. Most of the time, people rely on their credit card to make up for these unplanned-but-necessary expenses

Unfortunately, many consumers will have no idea that they are in way too deep in debt until it’s almost too late. It is only when they cannot keep up with their responsibilities that they realize they are in serious trouble. This results in a number of problems. Financial stress can create a range of difficulties in someone’s life and can eventually result in assets being seized. On top of this, a consumer’s credit score can be seriously damaged if they do not take care of their debt commitments in time. This can create future problems. If they act fast, they just might turn things around by getting a debt consolidation loan.

What is Debt Consolidation?

So, you may be wondering exactly what does debt consolidation mean? In simplest terms, debt consolidation takes all debts and combines them into a single loan with a single payment. Many people feel this option will give them more elbow room to ease their way out of their debt as they will only be making a single payment per month. But what do debt consolidation companies do? They also often refinance your debt when they consolidate it, which makes your payments much lower. For example, a debt consolidation company may give you loan to pay off all your current debt – you’re then responsible for paying them back the loan, most likely at a much lower interest rate than you were previously paying. But this isn’t the only way to consolidate debt, more information on various methods is provided below.

You may be wondering: what is the best way to consolidate debt? There are a few things to consider if one is inclined to make a debt consolidation loan. Most of the time, it depends on the individual’s credit score and nature of the credit. For example, if a consumer owns a home, he or she should start considering a home equity line of credit (HELOC) which utilizes the equity in a consumer’s home. This particular option looks at the consumer’s credit score and the amount of debt, which means the type of plan you are going to get depends on these two main factors.

Home refinance with cash out, on the other hand, is for consumers who still have a fair amount of equity in their property. The consumer then makes a new loan larger than the previous mortgage amount. He or she then uses the extra money to cover for the old debts.

Again, refinance with cash out puts consideration on the consumer’s credit score and amount of debt.

A third option that is popular among many consumers is a personal loan. Personal loans have become a viable option for paying old debts primarily because they incur generally less interest than credit cards and commonly have short loan terms. This is effectively the same as the loan discussed at the beginning of this section. Many banks and lenders offer personal loans that are specifically geared towards helping people refinance their debt.

The Hole

Many people view racking up debt as a temporary problem that can easily be escape. This is simply untrue – debt can create seriously problems for someone’s financial future. In fact, many people live their entire lives under the control of debt. The problem is that once someone enters a large amount of debt, they enter ‘the hole’. The hole is a system in which your debt dictates your future ability to accumulate wealth.

For example, let’s say that you rack up a large amount of credit card debt and you are unable to pay it off. You may be thinking that the best option is to default on the loan and try and start fresh. If you do default on the debt, a number of problems can emerge. Firstly, you may just end up getting back into credit card debt. Secondly, you may begin to find it hard to get any form of finance. In addition, if you are able to get a loan or another credit card, the interest rate that the lender will offer you will be much higher because your credit score will have been damaged by your previous default. This means that the debt or loan that you’re taking on will grow to be a larger burden because of the interest rate that you’ve been offered.

On top of this, because you have less access to credit, and the credit you do have access to comes at a high interest rate, you will be less able to take advantage of investment opportunities. This means that your ability to accumulate wealth is damaged in the long run. For all of these reason, it’s much better that you try and get out of ‘the hole’ as quick as possible – it will be much better for your future financial health.

The Advantages of a Debt Consolidation Loan

As mentioned, debt consolidation offers an advantageous opportunity for any borrower to settle their incurred debts. The one-payment-per-month-to-one-creditor scheme makes it easier for the borrower to keep track of their payments on top of dealing with a lower payment and interest rate. If you’re trying to decide if debt consolidation is right for you, it can sometimes be easier to look at things from a more concise perspective. Below is a full list of the benefits of consolidating your debt:

Reduced Number of Payments

With reduced number of payments, the borrower is saved from the stress and hassle of dealing with multiple creditors. This gives him/her more breathing room and reduce the chances of missing the payment due date, giving the borrower more time dealing with other pressing things in his/her life. Having multiple creditors can be an unnecessary stressor on someone who is unable to cope with a range of commitments.

Lower Payments

Aside from the outright advantage out shelling out less payments, seeking a loan consolidation can also allow the borrower and his/her family to get back on their feet and avoid committing the same mistake again. By consolidating your debt together your total monthly payments will be greatly reduced in most cases.

Lower Interest

With lower interest rates, any debtor can have ease off the burden of making heavy payments every month. Consumers should then make sure that they understand the terms of this new loan and they have full knowledge of what they will be paying on the proposed loan.

Getting Caught Up

If a borrower is constantly lagging behind his debts, a debt consolidation loan can help borrower catch up with other financial responsibilities. In some cases, a debt consolidation can allow the borrower to keep some extra cash and finally get ahead of his bills.

Getting Your Credit Score Back on Track

Once you begin paying off your debt, you will most likely see that your score improves in the long run. This is especially true because you will be paying off your credit card balances – credit cards tend to damage your credit score if you are carrying a high balance on the card. The more available credit that you use, the more your credit card will suffer. By taking out a consolidation loan and making on time payments, you will be putting yourself in a position to see your credit score rise to new heights.

Disadvantages of a Debt Consolidation Loan

As with anything, debt consolidation has its own “dangers” as well. Being out of the woods can be tempting for some if they don’t have a change of mindset on spending. Also, there always lies the risk of ending up paying more interest depending on the type of the loan you are getting.

Accumulating Credit Card Debt Again

While a debt consolidation loan promises to take the debt off your back, there is always the possibility of falling back in the debt hole once again if the borrower does not exercise discipline and self-control. Only those who have settled their debts through hard work and determination are unlikely to revert and wind up in debt again.

Those who take a debt consolidation loan and then maxing out their account’s credit find themselves in a worse situation than before. If they used their home equity to consolidate their debts and did a poor job of paying for the rest, they now have a bigger mortgage to pay and a lot to add their existing debt. These situations often put more things in their lives at risk.

Paying More in Interest

On rare occasions, borrowers actually end up paying more interest over the life of the loan. If a consumer chose a home equity line of credit or a home refinance, he/she is in for a 30-year term mortgage. This means, that even these options carry little interest, the length of the payment term makes the borrower pay more – maybe even more than the debt’s principal amount. This is why it is important to make sure you have a full understanding of the consolidation loan you’re getting – you should never end up paying more than what you’re currently paying.

Unchanged Spending Habits

Sometimes people just do not learn. Whether it’s because of their attitude or plain bad luck, some cases are not very inspiring. There are instances when the borrower becomes too relaxed and unworried that they end up going back to the habit of overspending and doing away with budgeting. With this attitude, the possibility of falling back in debt will be highly likely.

Short Term Credit Score Damage

So, what does debt consolidation do to your credit? In the advantages section, we mentioned that your credit score will improve in the long run if you consolidate your debt and make on time payments. This is true for responsible consolidators, but it must also be said that in the short term your credit will be damaged. This is because you are taking out an additional loan to refinance your current debt, credit bureaus will initially penalize you for taking our more debt to pay off others – as they do when you take out any new loan or credit card. But don’t let this deter you – in the long run, your credit will be much healthier.

Who Offers Consolidation?

So, after reading all of this you think that debt consolidation might be the right path for you. If this is the case, you’re just like the hundreds of thousands of Americans that have consolidated their debt in the past. While debt consolidation has grown in popularity in recent years, the concept itself has been around for ages. Many traditional lenders offer debt consolidation loans – there is a good chance that your consumer bank will be able to help you get one of these loans. But using a traditional lender can sometimes be time consuming – they require lengthy documentation and sometimes take weeks (or even months) to approve you.

If you need consolidation quickly, you’re much better using an online lender with a great reputation. Online lenders allow you to make instant applications – you can upload documents directly to the websites portal. In fact, online lenders are able to get you the capital you need much, much quicker. Sometimes within 24 hours! If you think that you want to start the process straight away, online lending can often be the best option.

Debt Consolidation Calculators

Before you decide if debt consolidation is right for you, head online and test the waters with a debt consolidation calculator. These calculators can help you see how much money you can save by using debt consolidation – there are plenty of free ones available if you do a Google search.

Head to some of the lenders that you are considering using and see what type of interest rates they offer for consolidation. Once you’ve done this, have a look at the current debt that you have and determine the interest rates that you’re paying. The calculators will allow you to put in interest rates, term times, and amount owed. You then put in the new interest rate that you will be using to consolidate. The calculator will provide you with analysis of the amount of money you can save by refinancing your debt. This is a great way to get a true understanding of the amount of money you will save if you refinance your current debt.

Those Unable to Qualify

Debt consolidation loans has seemingly become the borrower’s weapon of choice. However, with insufficient credit scores or unstable income, approval for a loan can prove to be difficult. The borrower, helpless and desperate, then sees that filing for bankruptcy is the only way out of this situation.

Bankruptcy is a very serious personal and financial decision. The implications of filing for bankruptcy ripples and stays on your record for a long time. In fact, the record of your bankruptcy will stay on your credit report for ten years. Within that period, you will have a hard time getting a mortgage if you don’t have one. You may lose some of your assets. The bankruptcy court can seize your property if it deems it ineligible for example. On top of that, you will no longer be allowed the use of any credit cards.

While bankruptcy seems to be the last option for borrowers who are in a serious amount of debt, it will not serve as a get-out-of-jail-free card. It does not relieve the borrower of all financial responsibilities.  For example, if a borrower/consumer is obligated to pay for child support or alimony, they must continue to do so even after filing for bankruptcy, and if he/she has as existing mortgage, that debt stays as well.

Another alternative will be to solicit the help of a debt relief company to help you get out of your debt problem. National Debt Relief works with borrowers to mediate and negotiate arrangements with their creditors. The NDR takes acts as an intermediary between the creditor and the borrower with the intention of communicating with credit companies to reach a reduced settlement amount. National Debt Relief helps consumers become debt free.

While the process of debt settlement does not happen in a breeze, and it will have some negative implications on your credit rating, it is an effective way of settling debt for borrowers who are stuck deep in debt. It’s really important that you don’t let your debt take over your life, debt consolidation is one way that you can take back control over the current chaos that may be causing your to make additional poor financial decisions.

Verdict

With any lender that you opt to work with, you should make sure to do adequate research into their business history – you don’t want to choose a lender that has a horrible customer service reputation. As with any form of finance, you need to make sure that there aren’t any hidden fees or charges. The best way to compare your different options is to ask lenders for a full cost of the loan at its maturity. You should also use a debt consolidation calculator to help you better understand the savings you may be able to make. Never use a debt consolidation loan that will end up costing you money – it may sound ridiculous, but it has happened to people in the past. Consider this an exciting time – you’re getting your life and credit score back on the right track!

FAQ

Debt Consolidation Loan Basics

Debt consolidation loan offers a great solution for those struggling to make monthly payments on their debts. To help determine if this is the best option for you (if you are in this similar situation), you can read more information below.

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What is a debt consolidation loan?

A debt consolidation loan is a type of refinancing that enables consumers to pay off multiple debts that you owe. Your multiple debts are rolled into one and then paid off in full. In exchange, you will get a new loan with a restructured payment scheme.

How does a debt consolidation loan work?

You will get a new loan of a sizable amount that is enough to cover your existing debts. Once your other debts are paid off, you can make new and lower monthly payments. This is usually intended to get rid of loans or debts with high interest rates.

Are debt consolidation loans a good idea?

If you are struggling to pay multiple debts at once, a debt consolidation loan is a good option. Since you are paying just one loan (instead of multiple loans), it will be easier to make monthly payments.

Do debt consolidation loans hurt your credit?

The impact of debt consolidation loans on your credit score will vary according to the options you choose. If you use it to consolidate your other debts and consistently make payments on the new loan, it will definitely improve your credit. If not, it can end up hurting your credit by obtaining a new loan.

Are debt consolidation loans taxable?

Yes, but if your debt consolidation loan is tied to an asset such as your home equity, you can qualify for tax deduction.

Can I get a consolidation loan with poor credit?

Yes. But since you have poor credit, you can expect for the interest rate to be higher.

What is a home equity debt consolidation loan?

Home equity debt consolidation is a type of debt consolidation loan that is tied to your mortgage or home equity. This is one of the best ways to ensure you can get fast approval on your debt consolidation loan.

How do credit card consolidation loans work?

In a credit card consolidation loan, you will be working with a lender to combine your existing credit card debts. Once combined, you will get a new loan to pay for those other credit card debts. You will be given a new interest rate on this new loan that you must pay on monthly installments. Check out how to pay off credit card debt with no money.

What is the interest rate on debt consolidation loans?

The interest rate is not the same for all and could vary wildly. Some can be as low as 5% while others can go up to 36%.

Will a debt consolidation loan help my credit score?

It depends on how you use your debt consolidation loan. If you use it to pay off your other debts, yes it can boost your credit. But if you are unable to pay your debt consolidation loan, it can hurt your credit.

What is needed for a debt consolidation loan?

You need to qualify for a debt consolidation loan if you have good credit or proof of income. But you can still qualify for debt consolidation loan even with bad credit with collateral.

What are costs of consolidation loans?

The cost of debt consolidation loan will vary according to your credit score, as it will determine how much you can qualify for a loan. The amount of debt you owe can be a factor too.

Do you need collateral for a debt consolidation loan?

Most debt consolidation loans will require collateral, but you can also find lenders that offer unsecured personal loans that can be used to consolidate debts.

Can you pay off a debt consolidation loan early?

Most lenders allow you to pay off your debt consolidation loan early without charges, but some might require upfront origination fees.

Can I use debt consolidation loans for something else?

Debt consolidation loans are designed primarily for paying off multiple debt accounts and combining them into one account. Thus, it cannot be used for other purposes other than this.

What is a good APR for debt consolidation loan?

Most interest rates for debt consolidation loans will start at 5%. If you can get 6.95% on your debt consolidation loan, that is considered good APR.

What are the drawbacks of a debt consolidation loan?

There are many potential drawbacks to debt consolidation loan, which includes the risk of not being able to pay the monthly installments on the new loan. When this happens, it can significantly lower your credit score.

What is an advantage of getting a debt consolidation loan?

The upside to getting debt consolidation loan is that it is easier to manage payments for your debts. You will be repaying just one loan per month instead of multiple debts.

Debt Consolidation Loan Provider

Choosing the right debt consolidation loan provider is crucial as it will determine the interest you pay and whether or not you qualify. Find the most common questions you will encounter when choosing a loan provider and the corresponding information to help you when choosing.

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What is the best consolidation loan company?

Choosing a debt consolidation loan company will depend on your needs and the amount of loan that you wish to consolidate. Each company will also differ in their requirements and the process of calculating the interest rate for the new loan. Use these factors when choosing where to consolidate your loans.

Do banks offer debt consolidation loans?

Yes. Some, but not all, banks can offer debt consolidation loans. The qualification requirements and other factors will vary from other credit institutions, though. Take a look at current Chase debt consolidation loan offers and see if they still do this.

Who offers the best debt consolidation loans?

It will depend on your needs and the amount of debt you wish to consolidate. Different debt consolidation providers will have different ways to calculate your interest rate. Make sure you choose accordingly.

Does Capital One do debt consolidation loans?

No, but Capital One can offer debt settlement and will link you to their loan partners when you are qualified for debt consolidation.

Who has the best debt consolidation loan rates?

The debt consolidation rates are calculated with the amount of debt you owe and your credit score in mind. Thus, it can vary largely from one provider to another.

Does Chase do debt consolidation loans?

Chase does not offer debt consolidation loans because they currently do not offer unsecured personal loans.

What banks do debt consolidation loans?

There are several banks that offer debt consolidation loans such as Bank of America, Wells Fargo, and Tesco Bank. Sometimes called debt relief loans these financial instruments can be used for a variety of purposes.

Does Navy Federal do debt consolidation loans?

Yes. They do offer debt consolidation loans or you can apply for personal loans to pay off your other debts.

Does Absa offer consolidation loans?

Yes. They recently introduced debt consolidation as one of their products.

Does USAA have debt consolidation loans?

Yes. There is indeed a USAA debt consolidation loan offered to their customers.

Does the VA offer personal debt consolidation loans?

Yes. You can apply for VA debt consolidation loan to pay for various types of loans including payday loans or credit card debts.

Does Wells Fargo do debt consolidation loans?

Yes a Wells Fargo debt consolidation loan is possible. Wells Fargo currently offers debt consolidation loans to their customers, except for federal student loans.

Does Standard Bank offer debt consolidation loans?

Yes. Standard Bank offers debt consolidation loans. You can consider them if you want to settle your multiple debt accounts.

Does Citizens Bank do debt consolidation loans?

If you are thinking of consolidating your debts, you can get apply for debt consolidation loan at Citizens Bank. You can get personalized rates during application.

Qualifying/Applying for Debt Consolidation Loans

How do you qualify for a debt consolidation loan? This is a common dilemma faced by those considering loan consolidation. In this section, you can get the information you need to know to determine how you can qualify.

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How to get a debt consolidation loan?

The first step is to look for lenders that will provide you with debt consolidation loan. Once you have a list, you must compare their interest rates so you can get a loan that is cheaper and easier to manage.

How hard is it to get a consolidation loan?

Getting debt consolidation loan is not hard if you have good credit standing. But even if you have low credit score, you can still qualify but for a higher interest rate than average.

Will I get approved for a debt consolidation loan?

There are several reasons why people can get declined for debt consolidation loan, such as insufficient income, problems with credit score, too much debt, or not enough credit history.

How to get a debt consolidation loan without collateral?

A typical debt consolidation loan will require collateral, such as your home equity. But if you cannot provide collateral, you must use an unsecured personal loan to consolidate your debts since these won’t require collateral.

How to qualify for a debt consolidation loan?

The qualifications will differ from one debt consolidation company to another. But most of them will have these general qualification requirements: proof of income, credit history, financial stability, and equity (or other types of collateral).

How to apply for a consolidation loan?

The first step is to find a lender that can provide you with debt consolidation loan. Once you have a list, you must compare their requirements to see which ones you may qualify for. From there, you can ask for quotes to find the best rates.

Is it easy to get a debt consolidation loan?

Getting debt consolidation loan is easy if you have good credit standing and have proof of stable income.

Should I take out a debt consolidation loan?

If you can commit to making your monthly payments on the newly consolidated loan, it is a good option. Otherwise, it can only add to your debt woes if you acquire a new debt.

Am I eligible for a debt consolidation loan?

Several factors can determine one’s eligibility for debt consolidation loan. But in general, you can qualify if you have good credit and have stable income source. Even if you don’t, you can still qualify but interest rates will be higher.

Debt Consolidation Loan Specifics

In this section, you will find questions and information about specific types of debt consolidation loans. You can also get information on how to choose which type of debt consolidation loan to match your needs.

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What is a direct consolidation loan?

Direct consolidation loan is a type of federal loan that works like a regular consolidation loan. It rolls into one two or more federal educational loans. Your new loan will have a fixed interest rate that is determined based on the average rate for all loans being consolidated.

What is a FFEL consolidation loan?

FFEL consolidation loan is a type of loan relief that is specifically designed for FFEL (Federal Family Education Loan) loans, which enables borrowers from the FFEL loan program to consolidate their debts into one.

Are FFEL consolidation loans eligible for forgiveness?

No, these types of loans are no longer issued so they cannot qualify for loan forgiveness. You can consolidate it into a federal direct loan instead, which will qualify for Public Service Loan Forgiveness.

Will consolidation loans cover auto loans?

Yes. Most debt consolidation loans nowadays can also cover for auto loans.

What does unallocated consolidation loans mean?

This refers to the amount within a consolidation loan that cannot be properly allocated to the corresponding subsidized/unsubsidized portions.

What is a federal consolidation loan?

Federal consolidation loan is a type of loan that is offered to loans obtained from federally owned entities. Unlike most consolidation loan options, the interest rate is determined by an average of the multiple debts you are trying to pay off.

Can you refinance a debt consolidation loan?

Yes. Debt consolidation loan still works like other types of loans like mortgage or a personal loan so refinancing is an option.

Should I get a private or federal consolidation loan?

Both of these consolidation loan options offer the same benefits. However, federal consolidation loans will not secure you a lower interest rate whereas private consolidation loans can. The federal consolidation loan rates are calculated as weighted average for all of your existing debts. For this reason, private consolidation loans might be a better option (especially if you consolidate for the purpose of lowering the rates).

Is Sallie Mae a direct consolidation loan?

No. Sallie Mae is no longer a federally owned entity. For this reason, it is not eligible for federal direct consolidation.

Dan Steadman

Dan Steadman

Financial Advisor, MoneyBeagle

Dan is one of the top financial experts when it comes to debt consolidation. With more than 20 years of experience helping people tackle debt, he has a unique insight when it comes to solving debt-related problems. 

Dan got his start when he went to work for a bank after getting his Business Degree. He worked his way up and became a loan officer. This position gave him unique insights into the ways that financial products work and how people can utilize different financial products to improve their lives. He’s seen hundreds of success stories and just as many failures – so he knows what steps are most likely to help his readers.

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