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 unexpected expenditure can make our lives 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 hobbies and other fun activities, 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 financial burden. One of the best debt relief options is consolidating it with a low-interest-rate credit card or a personal loan.
What is debt consolidation?
Debt consolidation is the strategy of combining multiple debts into a single loan or line of credit, with the primary goal of making it easier to pay what is owed. Potential benefits include better manageability, paying it off quicker, saving money on interest and fees, and improved credit scores.
What kind of debt can be consolidated?
The most frequently consolidated debt 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 that 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 free up as you pay down the balance, 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. But that depends on the company you use and your credit profile.
A personal loan can be obtained quickly. Sometimes on the same day. And your credit doesn’t have to be perfect. Most lenders offer personal loans from $1,000 to $50,000. However, you can find some offering loans up to $75,000 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 using a personal loan for debt consolidation
Depending on your circumstances, the minimum monthly payment you’re required to make could increase with a personal loan. That might not help if you’re already struggling to keep up with your monthly payments. The lender could also charge a high origination fee that’s withdrawn from your loan. A substantial upfront fee like this could cause you to take on even more debt by adding 10% or more to your total debt load.
With that in mind, 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, home equity 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 in the long run.
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, then be honest with yourself about your money management skills and the likelihood you’ll accomplish your goals with each method. What is technically cheaper on paper and when achieved perfectly, could end up costing you more if it offers the flexibility to reaccess the credit as debt is paid down.
Here’s a list of popular personal loan alternatives, along with some features of each:
Credit card: Consolidating with a credit card can be cheaper in the short term, especially when you combine debts by taking advantage of a balance transfer or other promotional offer. You can extend your savings by participating in credit card churning. But that can get complicated, and it usually requires excellent credit.
HELOC: A home equity line of credit, or HELOC, offers an extended repayment period and may provide lower fixed and variable interest rates, flexible payments, and can be tax-deductible. However, a HELOC requires homeownership with decent equity in the property, can take time to set up, and may require closing costs, insurance, an annual fee, and other fees.
Home equity loan: A home equity loan offers an extended repayment period, may provide a low fixed interest rate, a dependable monthly payment, and may be tax-deductible for you. However, a home equity loan requires homeownership with substantial equity, can take a while to receive funds, and may require closing costs, insurance, and other fees.
Cash-out refinance loan: A cash-out refinance loan allows for long loan terms, the lowest annual percentage rate (APR), and may 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 or decrease over what you’re paying on your current mortgage loan.
Cost comparisons
$15K Debt consolidation over 5 years with excellent credit
| Method | APR (est.) | Mo pmt. | Total int. | Total cost |
|---|---|---|---|---|
| Personal loan | 8.00% | $304 | $3,249 | $18,249 |
| Credit card | 16.00% | $365 | $6,886 | $21,886 |
| HELOC | 7.50% | $301 | $3,034 | $18,034 |
| Home equity loan | 7.00% | $297 | $2,821 | $17,821 |
| Cash-Out refi. | 6.75% | $295 | $2,715 | $17,715 |
This first chart estimates the difference in annual percentage rate, monthly payment, total interest paid, and total cost based on that information when someone with very good to excellent credit consolidates $15,000 in debt and pays it off over five years using each method.
This comparison table should give you an idea of the cost differences. Still, because there are so many variables to consider, the calculations do not include other items, like homeowners’ insurance, that you might have to pay for.
The lower your credit score, the higher your costs will be. See the two charts below for people with fair and good FICO and VantageScore credit scores.
$15K Debt consolidation over 5 years with good credit
| Method | APR (est.) | Mo pmt. | Total int. | Total cost |
|---|---|---|---|---|
| Personal loan | 15.00% | $357 | $6,411 | $21,411 |
| Credit card | 22.00% | $414 | $9,857 | $24,857 |
| HELOC | 9.50% | $315 | $3,902 | $18,902 |
| Home equity loan | 9.00% | $311 | $3,683 | $18,683 |
| Cash-Out refi. | 8.75% | $310 | $3,574 | $18,574 |
$15K Debt consolidation over 5 years with fair credit
| Method | APR (est.) | Mo pmt. | Total int. | Total cost |
|---|---|---|---|---|
| Personal loan | 28.00% | $467 | $13,022 | $28,022 |
| Credit card | 29.99% | $485 | $14,113 | $29,113 |
| HELOC | 12.00% | $334 | $5,020 | $20,020 |
| Home equity loan | 11.50% | $330 | $4,793 | $19,793 |
| Cash-Out refi. | 10.75% | $324 | $4,456 | $19,456 |
How to use a personal loan to consolidate debt
To use a personal loan to consolidate debt, you’ll first want to get an idea of your chances of being approved for a personal loan. Many online lending platforms, such as Upstart, make that process easy by allowing you to get prequalified over the internet without affecting your credit score. They do this using a soft pull of your credit report.
If you are offered a loan but don’t like the terms, you can shop and compare offers from other online lenders, or contact your local bank or credit union to see what they can do for you.
If you have a good credit score, you should have decent success by shopping around. Unfortunately, your options will be limited if you have what is considered fair, poor, or bad credit. In those cases, finding an online lender with high fees might be the only realistic option, but it might still be better than your current situation.
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 completed within 1 to 5 business days.
Online lenders are typically the quickest option for obtaining a personal loan because they use streamlined, digital processes that allow for applications, approvals, and funding to be handled entirely from home.
When your funds arrive, you should begin paying off your other creditors immediately. You can pay them online, by phone, by check or money order, in person, or otherwise.
What happens after my debts are paid off
Once your other debts are repaid, it might be smart to close those accounts. Whether you should or not depends on the type of accounts you have open and your individual goals. If you have credit card accounts you’re worried about charging up again, you should probably close them. However, I would consider keeping one open for emergencies.
Just keep in mind your credit score could take a slight hit initially. This ding to your credit score 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 immediately. 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 from now on, your credit score should rebound quickly. Hopefully, faster than you expected, and go higher than right before you started consolidating. Just be sure to make your payments 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 make large purchases, it can also be an effective tool for consolidating debts. A personal loan makes it easier to manage your debt in one place by offering a consistent monthly payment and a definitive maturity date. Moreover, personal loans typically have fixed interest rates, whereas most credit cards have a variable APR.
Just be careful if you’re in the process of buying something expensive on credit, like a home or a car, as this new account could temporarily reduce your credit score. That reduction could prevent you from closing on the other loan, even if you’ve been preapproved.
Once you combine all of your unsecured debt and make a few on-time payments, you should begin to feel some relief and see your credit score improve.
So, should you consolidate debt with a personal loan? The answer to that will depend on your unique circumstances, but it can be a wise choice for many people. Hopefully, after reviewing these pros and cons of consolidating debt with a personal loan, you are in a better position to decide what to do.