Taking out a personal loan can often be a smart financial move. A personal loan can help you pay off more expensive debt, make a major purchase, or achieve other financial goals. If you’re paying off more than one of these loans, knowing how to consolidate personal loans can put you a step ahead.
Many people think consolidation is mostly a tool for people with bad credit or sketchy payment histories, but the opposite is usually true. You’ll probably need a fairly strong record of prompt payments in order to qualify for debt consolidation products that will help relieve your financial stress.
A survey from Lending Tree indicates that debt consolidation is the most popular use of personal loans among borrowers with good credit scores.
If you’re juggling two or more personal loans at the same time, debt consolidation could be the right tool for you. Let’s look at what debt consolidation is, how it might help you manage your money, and how to consolidate personal loans.
What is Debt Consolidation?
Debt consolidation, at its core, is the use of credit to combine two or more personal loans (or credit card balances, student loans, or other types of consumer debt). In most cases, you’ll take out a new loan or credit card, use it to pay off two or more old debts, and then pay off the new debt.
Consolidation does not make debt disappear: you still owe the money. It can simplify your payments – one payment a month instead of two or more – and could reduce your interest rate.
Consider what happens when a consumer is carrying two or three personal loans with substantial interest rates. The payments have different schedules, making it easier to forget one. Even one late payment can damage your credit, and you’ll have to be sure you have money available at different times of the month
Consolidation can make multiple payments easier to manage and reduce your chance of missing a payment. You could also get a cheaper loan, especially if your credit has improved since you took out the loans you’re currently paying.
For example: The average interest rate for an unsecured two-year personal loan in May 2022 was about 8.73% according to the Federal Reserve. If you have personal loans with that interest rate and can qualify for a loan with a lower rate, you can wind up with a single payment that’s less than the combined payments on your other loans.
Why Should You Think About Consolidating Your Personal Loans?
If you consolidate with the right lender or institution and shop for the best possible deal, you may qualify for a lower interest rate. That could reduce the amount you will be obligated to pay over time.
If your new loan has a longer term than your old loan, debt consolidation may also reduce the amount of your monthly payment. This in turn improves your cash flow and helps free up funds for other purposes, possibly helping you get out of debt more quickly.
Remember that even with a lower rate, a longer term may increase your total interest expense! Use a tool like our loan calculator to determine exactly how much interest you pay on a loan.
Finally, consolidating multiple monthly payments into one can help you organize your financial life better and maintain a better credit score.
How Does Debt Consolidation Work?
There are three main ways to consolidate debt.
1. Personal Loans
One way to consolidate debt is to use another personal loan. Personal loans are a popular way to consolidate debt, and some are even marketed specifically as debt consolidation loans. In these cases, your new lender will pay your old creditors directly.
You’ll need to shop around for a new personal loan at a lower rate than your old loans. It will help if your credit score has improved since you took out your existing loans.
2. Balance Transfer Cards
Another common method of debt consolidation is to use a balance transfer credit card. Many of these cards have an extended interest-free promotion on balance transfers. You can transfer your old balances to the card and pay them off without interest.
This only works if you can pay the total sum before the promotional period expires. If you can’t you’ll be paying credit card interest rates – typically higher than personal loan rates – on the debt.
Make every payment on time: a late payment could cancel the zero-interest promotion.
You may have a hard time finding a balance transfer card with a high enough limit to pay two or more personal loans. Even if the limit is high enough, you may be carrying high credit utilization on that card, which could harm your credit.
You will need good credit to get a balance transfer card with competitive terms.
3. Home Equity Loan
A home equity loan can be an excellent way to consolidate your personal loans. These loans are secured, so approval is generally easy and interest rates are relatively low. You may qualify for a relatively long loan term, which can keep your monthly payments affordable.
The downside is that you can’t use this method unless you own a home and have sufficient equity to support a large enough loan. There’s also a risk: if you default you could lose your home.
Should You Consolidate Your Personal Loans?
The short answer is “maybe.” Consolidation is effective for consumers who have control of their spending habits and are reasonably certain the consolidation will lower their monthly bills and help them get out of debt more quickly. You’ll need a good credit score in order to qualify for a consolidation loan that will help you accomplish those goals.
Assess your credit and debt situation honestly. If your debt-to-income ratio is under 35% and your credit score is good or very good, you can be confident you’ll get a competitive consolidation rate to make it a worthwhile choice. Just be sure to shop for the best rates and evaluate the terms carefully.
Managing your debt is critical. Some consumers use the breathing room offered by consolidation to simply incur more debt. This will make debt consolidation ineffective. Additionally, if your credit history is sparse or short, or your credit score is below a good rating (around 680 to 739), then you may not qualify for consolidation products with low enough interest rates to save you money in the long run.
Finally, take a close look at the remaining terms on your current personal loans. If you reasonably think you can get them paid off within the next year or so and you’re managing your existing payments without problems, it’s probably not worth the costs of incurring another loan to consolidate them.
Loan Consolidation Calculator
Use the loan consolidation calculator below to see how much you can save if you choose to consolidate your personal loans. You can input up to 3 different loans with their current terms and the calculator will show you your new monthly payment and how much you can save in interest payments.
The Last Word
If you’re carrying more than one personal loan, knowing how to consolidate your personal loans could be a key to managing those debts. “Could be” doesn’t always mean “will be”. Each case is different, and you’ll have to evaluate your debt situation and your consolidation options to know if consolidating your personal loans is the right move for you.