A debt consolidation loan is one way to refinance your debt. You can apply for a personal loan for the outstanding amount of money you owe and use the loan to pay off your balance. This loan is then paid back over time.
Debt consolidation loans are a popular way to roll various forms of high-interest debt into one single affordable payment. Often, debt consolidation can lead to a lower payment overall.
How does a debt consolidation loan work?
Debt consolidation loans are similar in many ways to standard personal loans with the added benefit of allowing you to merge your separate debts into a single, more convenient monthly payment, ideally with a lower interest rate than the average interest rate of the debts you’re consolidating. However, your interest rate for a debt consolidation loan may also be affected by your creditworthiness and income.
Imagine you have three credit cards with different balances and different interest rates. This can not only become confusing, but it can also mean you’re paying far more interest than you should be.
A debt consolidation loan can be used to combine all these credit card balances and interest rates into one loan. This can simplify your monthly payments into a fixed amount, so you avoid surprises. Fixed payments also allow you to know when the loan will be paid back far in advance.
Benefits of debt consolidation loans
Getting a loan to consolidate debt comes with several benefits:
- Pay off your debt faster: Repayment timelines can stretch for years if you keep making minimum payments. Debt consolidation loans could speed up this timeline, allowing you to consolidate your multiple debts into a single debt and potentially pay the debt off faster.
- Simplicity: By consolidating all your debt into a single account, you can simplify the legwork needed to pay the money back. Seeing your debt in one place instead of several different accounts can make repayment much more manageable.
- Fixed repayment: Many debt consolidation loans are fixed installment loans. This helps in two ways. First, it provides stability in knowing exactly how much you will owe each month. Second, it offers a way to calculate exactly when you will be debt-free.
Risks of debt consolidation loans
Debt consolidation loans do have some downsides:
- Temporary credit score damage: Applying for a debt consolidation loan may lead to a hard inquiry on your credit score. This could temporarily decrease your credit score, but remember – consolidating high-interest debt could likely improve your credit score long-term.
- Higher interest rates: While the goal of a debt consolidation loan is often to lower interest rates, you could fall into a trap. If you choose to go with lower monthly installments for your loan, it could stretch out the length of time you spend repaying it. The longer you take, the more interest will accumulate. Be sure to consolidate your debt into an affordable monthly payment that allows you to pay it back quickly enough to avoid overwhelming interest.
- Spending beyond your means: Consolidating your debts can create the illusion of greater financial freedom. If you consolidate a high-interest debt but continue your habit of spending beyond your means with credit cards, you will incur even more debt after repaying the original loan. Be wary of how your spending habits shift after you receive a debt consolidation loan.
How to apply for a debt consolidation loan
Applying for a debt consolidation loan can feel overwhelming. You can manage the process by being thorough with your preparation and your knowledge of your finances. Follow these steps when figuring out how to apply for a debt consolidation loan:
- Check your credit score: A good credit score makes you more likely to be approved for a loan. It also increases your chance of getting a lower interest rate.
- Evaluate your debts:This is a key step to ensure you get the right debt consolidation loan. Make a list of all the debts you plan to consolidate and add up the amount. You should also note the interest rates of your current loans and weigh them against the potential interest rate of your debt consolidation loan. Doing this will help inform the value of the loan you need to get. Make sure the new loan fits your budget and has a sufficiently low monthly payment. In doing this, you may find debt consolidation is not the right move. Using a debt consolidation calculator can also help you determine whether you need a loan.
- Gather documents: Lenders generally require proof of identity, address, and income before handing out loans. You can prove your identity with documents such as a government-issued ID or passport. Documents including a driver’s license or utility bill can verify your address, while recent pay stubs and bank statements can prove income.
- Compare loan options: You can get a debt consolidation loan from banks, online lenders, credit unions, and more. It is important to compare your options to ensure you get the best loan for your specific situation. Compare interest rates, loan terms, fees, and monthly payment options.
Debt consolidation loan interest rates
Interest rates on debt consolidation loans can vary, with the potential for both higher and lower rates. In general, having a higher credit score tends to increase the likelihood of securing a more favorable interest rate.
Additionally, lenders look for people with a low debt-to-income ratio, which shows how much of your income goes to monthly debt payments. Your income also plays into the interest rate. The lender will want to make sure you make enough money to pay back the loan.
What to do if the loan application is denied
There are several reasons why your debt consolidation loan application could be denied. Your credit score may be too low. Maybe the lender believes your income is not high enough to cover the loan. A lender may even deny a loan application if they feel you have too much debt and pose a risk.
If your debt consolidation loan application is denied, there are steps you can take.
- Work to improve your credit score and find ways to cut down on your spending and increase your income.
- Build a budget to ensure you can put yourself in the correct financial position to re-apply for a debt consolidation loan.
- Speaking with a credit counselor could be an excellent way to address your credit score and learn how to improve your financial situation.
Frequently Asked Questions
Which types of debt can I consolidate?
There are several types of debt you can consolidate. One of the most popular debts to consolidate is credit card debt. Unpaid medical debt and payday loans can also be consolidated in some cases.
You can also consolidate student loans. While it is possible to have one monthly student loan payment, some students take out new loans each semester. This can cause student loans to pile up. Debt consolidation is an option in this scenario but be warned: consolidating federal loans could lead to losing benefits such as income-based repayment. It may be wiser to consolidate only private student loans.
High-interest personal loans can also be consolidated. Consolidating expensive personal loans into more affordable monthly installments can make sense, especially since consolidating installment loans will not lower your credit utilization rate.
What is the minimum credit score for a debt consolidation loan?
It is always a good idea to have a higher credit score in order to secure a lower interest rate on your debt consolidation loan. However, the minimum credit score lenders require can be 720. Some lenders may even go as low as 680.
How much debt do I need to consolidate?
The amount of debt you need to consolidate varies from person to person. Loan amounts also vary, but lenders can offer anywhere from $2,000 to $30,000. The amount you receive will depend on your credit score and financial situation.
How is a debt consolidation loan different from a credit card?
A balance transfer credit card usually charges 0% APR (annual percentage rate) on balances for a limited time, allowing you to pay your debt without accruing interest for a predetermined introductory period. However, if you fail to pay back the balance before the introductory period ends, you will likely be charged a higher interest rate than you would be with a debt consolidation loan. If that happens, you could be stuck paying more high-interest debt than you intended.
How long does it take for a consolidation loan to get approved?
In some cases, approval for your debt consolidation loan can be instant. In others, it could take up to seven business days to complete the entire process. The amount of time it takes to get approval depends on the lender and your financial situation.
Debt consolidation loans can be a huge help. They can simplify your outstanding balances, lower your interest rate, and allow you to easily plan for a debt-free future. But these loans do not come without risks. It is crucial to do your research and ensure a debt consolidation loan is the right move for your unique financial situation. Citi offers personal loans to both existing Citi customers and new Citi customers that meet specific eligibility criteria, including an established credit and income history along with additional factors determined by Citi. If you think you could benefit from a Citi Personal Loan, apply online today.
Disclosure: This article is for educational purposes. It is not intended to provide legal, investment, or financial advice and is not a substitute for professional advice. It does not indicate the availability of any Citi product or service. For advice about your specific circumstances, you should consult a qualified professional.