What Is A Debt Consolidation Loan?
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Consolidation Loan Definition
A consolidation loan is a great way for consumers to get out from under debt and try to turn their finances around when they have maybe taken on more than they can handle. It can be too easy sometimes to take on new debts without paying off old ones, and someday it may get to the point where you are struggling to make all your monthly payments. Additionally, the interest that you may be accumulating while only making the minimum payments across several maxed-out credit cards can sometimes be astronomical.
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Learn More About What Is A Debt Consolidation Loan?
With a debt consolidation loan, you can pay off all your high-interest credit cards and loans, and consolidate them all under a new loan with ideally a better interest rate. With only one monthly payment to worry about you can simplify your finances and focus on paying down your debt as much as possible each month.
Read more - FAQ+
What is a consolidation loan and how does it work?An added benefit of a consolidation loan is that you may have a lower monthly payment after obtaining the loan compared to when you needed to pay several creditors various amounts across different accounts each month.
However, it is important to know that you do not need to be falling behind on your debt payments to want to obtain a debt consolidation loan. A debt consolidation loan could be used by a borrower who may be able to keep up on all their payments each month but may feel overwhelmed trying to keep track of all the different due dates. Even with autopay, payment amounts on credit cards can change and it may be difficult to keep track of exactly how much each account is taking from your checking account each month. With a personal debt consolidation loan, you can pay off all of those debts and have one single fixed monthly payment that may never change throughout the loan duration. You will always know exactly how much you will need to pay each month, and if you have a lower monthly payment, you can use that surplus to create some savings, invest, or make extra payments to pay down your debt sooner. If you focus on your finances, make some spending cuts to save money, and do not take on any new debt, you could potentially be debt-free once the loan is paid in full.
Another reason that you may want to take on a debt consolidation loan is that you have worked hard on your credit and now your credit score is significantly higher than when you first took on the original debts. With a much higher credit score, you may be able to qualify for a debt consolidation loan with a much lower APR than your existing debts. Because of this, taking on a new loan with a lower APR can give you an opportunity to save quite a bit of money in the long run by requiring you to pay less interest during the loan duration and by setting a firm pay-off date. When you only make the minimum payments on your credit card accounts, you could be stretching out your debt payments for months or even years longer than they need to be, which then becomes more and more expensive the longer you take to pay off your debt.
For whatever reason that you decide that debt consolidation may be right for you, the first thing you may need to consider is which type of debt consolidation loan is the best considering your circumstances. There are several different types of debt consolidation loans that each come with their own advantages and disadvantages and that may work for some consumers while others may not. For example, a home equity debt consolidation loan can only work for a borrower who owns their own home and who has at least 20% equity built into their home.
Now keep in mind that debt consolidation is completely different from debt settlement. You may hear these two phrases used interchangeably, which is incorrect. Make sure you understand the difference between these two processes before reaching out to any entity that claims to be a debt settlement company. A debt settlement company is an entity that negotiates lump-sum payments to each of your creditors in exchange for charging you a fee somewhere between 15% to 20% of the total amount.
A debt consolidation process is a process that involves obtaining a new loan from an official lending institution to pay off all of your current debt, and in exchange, you make one single monthly payment plus interest that is equal to the market rate you qualify for based on your credit score. Essentially, debt settlement companies could be considered somewhat predatory while debt consolidation loans through certified lenders are considered more safe, secure, and an official way to pay off existing debts. So, what are the different types of debt consolidation loans available to you?
Here is a list of some of the most common ways borrowers like yourself choose to obtain a debt consolidation loan to pay down existing debt and simplify their finances.
Home equity loan: If you have at least 20% equity built up into your home, you can tap into that equity through a home equity loan or a home equity line of credit. Equity is essentially how much your home is worth versus how much you have paid on your current mortgage. By subtracting the mortgage balance from the current home’s fair market value, you can determine how much equity you have. If your equity is greater than 20%, a home equity loan provider may allow you to borrow up to 80% or 90% of your total equity in a separate second mortgage home loan.
You do not have to borrow the entire 80% or 90% of your equity and instead, you can opt for a smaller amount. Keep in mind that if you do take out a home equity loan, you will be taking on a second monthly payment in addition to your current mortgage payment. This may affect how much equity you would like to borrow against based on how high the monthly payments could potentially be. Common home equity loan terms come in 5, 10, or 15-year fixed-rate loans. A fixed-rate loan comes with a fixed APR and a fixed monthly payment.
One of the best things about a home equity loan is that you can access larger loan amounts at lower interest rates compared to a personal loan. That means if you qualify for a larger home equity loan, you may be able to not only consolidate your existing debts, but you also may be able to fund a home improvement project, pay for going back to school, or even use some funds to start up a new side gig to create a new revenue stream around a passionate hobby of yours. The reason that it is easier to qualify for large amounts of cash with a home equity loan is that you are using your equity and essentially your home as collateral to secure the loan. By using your home as collateral, you may be putting yourself at risk of losing your home if you are unable to make payments, however, you can typically obtain larger amounts and lower interest rates in exchange.
Home equity lines of credit: HELOCs are very similar to home equity lines of credit, however, instead of one large lump sum payment, HELOCs typically contain a draw period and a repayment period. For example, a lender may qualify you for something like 85% of your equity and establish a credit limit. Instead of getting all the money upfront, you are allowed to draw against that credit limit and take as much or as little as you would like while the draw period is in the draw phase. During that time you can make regular monthly payments on the amounts borrowed or you can choose to only make interest payments. Once the draw period comes to a close, you then enter the repayment period. If you were only making interest payments, then monthly payments may dramatically increase to make up for the smaller monthly payments you were paying previously. If you were making regular payments, then you may only see a slight change in the required monthly payments.
A typical HELOC may have a draw period of 10-years and a repayment period of 20-years. If you are making regular monthly payments during the draw period, you are also constantly replenishing your credit limit and increasing the amount you could potentially withdraw from. Additionally, if you are making regular monthly payments, a lender may offer to allow you to renew the HELOC and extend the draw period. Like a home equity loan, a home equity line of credit may put your home at risk if for some reason you are unable to make the payments.
Cash-out refinance: A cash-out refinance may be a good way to get your hands on some extra cash to consolidate all your existing debts. Essentially, if you are already looking to refinance your home in order to take advantage of lower interest rates, you can ask for a new mortgage that is for an amount that is greater than your current mortgage. Once the cash-out refinance is complete, you can take the bulk of the funds to pay off your current mortgage and then take the surplus funds to pay off all your creditors.
Credit card balance transfer: If it is only credit card debt that you are looking to refinance, or if some of your creditors accept credit card payment, then depending on your credit score, you could always apply for a new credit card that comes with a 0% APR introductory rate. Typically these promotional periods can span 12 to 18-months. Although you may still be subject to a balance transfer fee, you can take advantage of the 0% promotional period to pay down as much of that debt as possible before interest kicks. Again, in order for this to work, you may have to already have a good or even excellent credit score.
401k loan: If you have a 401k retirement account, you may be able to borrow against your retirement savings as a form of debt consolidation. However, many financial advisors may recommend only using a 401k loan as a last resort. The main reason for this is any funds that are removed from your 401k could potentially miss out on large gains that can benefit your retirement. Also, if for any reason you are unable to pay back the loan, you most likely will have to pay early withdrawal penalties and count the amount unpaid as income on your taxes.
Personal debt consolidation loan: Personal debt consolidation loans are one of the most simple and commonly used forms of debt consolidation. Applying for a personal debt consolidation loan should be a simple and straightforward process. In some cases, lenders may just offer personal loans that can be used to consolidate debt. In some other cases, lenders may offer debt consolidation loans with direct payment to creditors. This means that you apply for the loan and notify them of the accounts you wish to consolidate. If approved, the lender will pay off the accounts and roll the debt into the new loan. The simplicity and less strict qualification requirements of personal debt consolidation loans make them a preferred choice.
If you are considering debt consolidation, then you may want to take some time to consider all of your options. Some options may be better than others depending on your credit history, income, whether or not you own your home, and what your financial goals are. Again, one of the most common forms of debt consolidation is a personal debt consolidation loan. If you may be considering a debt consolidation loan, how do you know which lenders offer the best consolidation options? Here is a breakdown of some of the most trusted online lenders who specialize in debt consolidation.
Best Consolidation Loan Options:Lightstream
Top pick for: large personal loans
Qualifications: LightStream may be a good debt consolidation lender for a borrower who has a large amount of debt and who has a credit score of at least 660 and a minimum income of $50,000.
Joint applications are allowed
Rate discount for signing up for autopay
No prequalification application on the LightStream website
High minimum credit and income requirements
Inflexible due dates
No direct payment to creditors
Why choose: LightStream offers debt consolidation loans of up to $100,000 with 2 to 12-year repayment terms and competitive interest rates for those who qualify.
Top pick for: debt consolidation loans for good credit
Qualifications: SoFi requires a minimum credit score of 680 and a minimum income of $50,000 for a personal debt consolidation loan between $5,000 and $100,000.
Zero fees. No origination fee, late fee, or early pay-off penalties
Co-applicants are allowed to increase their chances of qualifying or to access lower interest rates
Direct pay available for select creditors
Higher credit score and income minimum requirements
Co-applicant loans can take two weeks longer to be approved
Why choose: If you are having debt problems, SoFi does offer some free financial planning and mentoring services.
Top pick for: debt consolidation loans for fair credit
Qualifications: Best Egg requires a minimum credit score of 600 for 3 and 5-year debt consolidation loans that range from $2,000 to $50,000.
Offers direct payments to creditors for debt consolidation loans
Flexible due dates
No early pay-off penalty
Higher than average APRs
Charges an origination fee
Does not permit co-applicants
Why choose: BestEgg is well-known for having good customer support.
Top pick for: peer-to-peer loans $40,000 and less
Qualifications: For a 3 or 5-year debt consolidation loan for an amount between $2,000 and $40,000, Prosper borrowers will need a minimum credit score of 600.
Allows joint applications
Offers debt consolidation loans of up to $40,000
Charges an origination and late fee
Not available in every state.
Why choose: Prosper may be a good lender option if you want to manage your account and your loan from your mobile device using an app.
Top pick for: debt consolidation loans for bad credit
Qualifications: Upgrade requires a 560 minimum credit score for debt consolidation loans that range from $1k to $50k. Loan terms can be anywhere from 3 to 7-years.
Wide range of loan amounts and loan repayment periods
Ability to prequalify on the Upgrade website with no impact on your credit score
Offers to pay creditors on your behalf for debt consolidation loans
Secured loan options are available for poor credit borrowers or for any borrower hoping for a lower APR
Higher APRs than other lenders
Charges an origination fee
Not available in all 50-states.
Why choose: Upgrade specializes in working with borrowers with bad credit.
Top pick for: debt consolidation loans for excellent credit
Qualifications: Axos requires a minimum credit score of 700 and a minimum income of $48k for debt consolidation loans that range from $5k to $50k.
Fast approval and funding
No early payoff penalty
Charges an origination fee
Why choose: Axos is known for helping borrowers refinance existing loans or complete the debt consolidation process.
Top pick for: debt consolidation loans for credit challenged borrowers
Qualifications: A minimum credit score of 600 is required for a personal debt consolidation loan between $1,500 and $20,000.
Accepts low credit and low-income borrowers
Offer a secured loan option for easier qualification and lower interest rates
Offers access to a mobile app to manage your account, make payments, and check your VantageScore
Maximum loan is $20,000
Why choose: If you need fast funding, OneMain Financial can help you with that.
Top pick for: low income borrowers
Qualifications: With a minimum credit score of 600 and a minimum income of $30k, you may be able to qualify for a 2 to 4-year personal debt consolidation loan for an amount between $2,000 and $25,000.
Lower credit score requirements
Fast loan approval and funding times
Offers smaller loans with 2 to 4-year repayment terms
No co-signer or secured loan options
Higher than average APRs
Charges an origination fee of up to 6%
Why choose: LendingPoint is good for borrowers looking for a smaller amount and a more short term loan.
What is the purpose of a consolidation loan?The main purpose of a debt consolidation loan is to combine multiple debts into one single monthly payment by obtaining a new loan with much more favorable terms. Once the new loan is acquired, you can then pay off all your existing high-interest debts and exchange them for a single debt with ideally a lower interest rate and a lower monthly payment. If you are able to obtain a lower monthly payment compared to the total amount you were paying per month between all the different creditors, you can then take any extra funds each month and devote them to paying down your debts faster or building up savings.
What qualifies you for a consolidation loan?The kind of qualifications that are necessary for a consolidation loan varies by the loan type and the lender. For example, a home equity loan used for debt consolidation is going to have different qualification requirements than a personal loan. Obtaining a 0% APR credit card with an 18-month promotional period is also going to have different qualification requirements than both the home equity and personal loan. Let us take a closer look at these three debt consolidation methods to get a better understanding of what lenders may be expecting from a potential borrower.
Home equity loan or home equity line of credit: To qualify for a home equity loan or home equity line of credit you may need at least 20% equity in your home, a good credit score, a lower debt to income ratio, sufficient income, and reliable payment history. A good credit score may be better if you have a credit score over 700, however, a credit score in the mid-600s may be enough to qualify for a home equity loan or HELOC since you are using your home as collateral to secure the loan. When it comes to debt-to-income ratios, you should aim for a debt-to-income ratio that is below 36%, however, some lenders may go as high as 43% or 50%.
When it comes to income, most lenders will consider your income when they calculate your debt-to-income ratio, however, they also want to see a consistent employment history with a consistent monthly income. The longer your employment history, the better. When it comes to reliable payment history, yes lenders will get an idea of your payment history when they see your credit score, however, once they have the hard inquiry credit check in front of them, they may take an even closer look at your payment history to identify any potential risk.
Personal debt consolidation loan: To qualify for a personal loan for debt consolidation purposes lenders can look at your credit score and credit history, your income, your debt-to-income ratio, and even some of your personal finances to get a better idea of how you manage your money. When it comes to credit score and credit history, most lenders are going to want to see a minimum credit score above 600 with no recent negative credit events in your credit history.
Negative credit events may include a previous loan default, home foreclosure, car repossession, or bankruptcy. These negative credit events do not automatically disqualify you, however, lenders may want to see that these types of events happened long ago and since then you have a near-perfect payment history. When it comes to that 600 minimum credit score, some lenders may require an even higher credit score between 600 and 700, and some lenders may even go lower than 600.
Minimum requirements for a personal loan depend entirely on the lender. When it comes to your income and your debt-to-income ratio, lenders are going to want to see a stable employment history with a lower debt-to-income ratio. You want to aim for a DTI that is below 36% including the loan you are applying for. When it comes to your personal finances, some lenders like to see evidence of savings or that you have the ability to save money. This is why sometimes a lender may request bank statements to review during the loan application process. When you are ready to apply for a personal debt consolidation loan, you most likely will need to submit documents that verify your identity, employer, income, and address. Once the loan is approved, loans can be funded in as little as 1-2 business days, although funding times can vary.
Zero-interest credit card: To qualify for a new 0% APR credit card, you may need a minimum credit score of 700 for the best chances of qualifying. Once you are approved for the new credit card, the 0% APR is typically an introductory rate. The introductory rate can span for a 12 or 18-month promotional period depending on the credit card company. Although the credit card company may charge a balance transfer fee, once you have access to your new line of credit, you should transfer all the balances of your other high-interest credit cards onto the new card.
Again, qualification requirements differ based on the lender type and the form of debt consolidation you are seeking. For the most accurate information about the costs associated with debt consolidation, you may want to prequalify for a home equity loan or a personal loan. Once you prequalify, you can begin to review personalized credit offers from various lenders.
Does credit consolidation ruin your credit?No, debt consolidation should not ruin your credit. In fact, it can actually help you to repair bad credit and increase your credit score over the duration of the loan. During the application process, lenders can do a hard credit pull. Hard inquiries can sometimes cause a credit score to drop about 5-points, but typically, no more than that. Also, if you take out a larger personal loan that is for an amount greater than your current debts, you could be adding to your overall debt amount which could also adversely affect your credit score. Once monthly payments kick in, you should make sure you make every effort to submit each of your payments on time and in full.
If you are late on any payments or you miss a payment, your credit score could start to decrease quite a bit. Payment history accounts for 35% of a borrower’s credit score. Therefore, any late or missed payments carry a lot of weight to dragging down your credit score. However, the opposite is true as well. If you continue to make all your payments on time, not only can you make up for the immediate dip you saw in your credit score once when you first took out the loan, you can begin to see an increase in your credit score the more payments you make on time and the lower the loan balance gets.
How long does debt consolidation stay on a credit report?This is where some people get confused about the definition of debt consolidation versus debt settlement. If you obtain a debt consolidation loan, it is treated no differently by the credit reporting agencies than a regular personal loan. Make all the payments on time and pay off the full loan balance and you are good. A debt settlement is treated differently. A debt settlement is an offer to pay a delinquent account at a discounted rate to resolve the matter and remove the account from delinquency on the credit report. Once a debt is settled, although the account may no longer be considered delinquent, the previously missed payments and other negative credit events tied to the account can stay on your credit report for up to 7-years from the date the account was first reported delinquent. This date is referred to as the original delinquency date.
How long after debt consolidation can I buy a house?Once you take on a new debt consolidation loan, you may want to wait a minimum of a few months to get some on-time payments under your belt to boost up your credit score before starting to look for a new home mortgage.
Can I still use my credit card after debt consolidation?Yes, you can still use your credit card after debt consolidation. Debt consolidation does not close your credit card accounts, it only wipes the balance. However, if you start using the cards again and you are paying on the loan, there is a good chance you are going to increase your debt burden even more.
How can I put all my debt into one payment?The debt consolidation process takes all of your debts and combines them into monthly payments through a new personal loan.
Is there a government debt relief program?There are no government programs that forgive or reduce consumer debt. Instead, there are 501c-3 nonprofit credit counseling services that can help you to address your debt issues.
Is refinancing the same as consolidation?If you are combining several debts into one, that is consolidation. If you are replacing one debt for another debt with a lower interest rate and more favorable terms, that is refinancing.
How does a consolidation line of credit work?If you open a personal line of credit, you can use some or all of your credit limit to pay off existing debt which effectively would be a form of debt consolidation.
Can I buy a car after debt settlement?Yes, you should be able to still buy a car after a debt settlement depending on how severe the settlement was and how much it impacted your credit. If you do try to get a car loan after a debt settlement, then you may have to pay higher interest rates and fees.
Can I cancel my debt consolidation?If you are enrolled in a debt management program, then yes you may be able to cancel at any time. However, if you take a personal debt consolidation loan, sign the loan agreement, and accept the funds, you may not be able to cancel. However, if you do not spend any of the money, you may be able to pay off the loan in full with the funds immediately. Just be careful of early pay-off penalties.
Does debt consolidation give you money?If you add up all the monthly payments you are making on all of your existing debts, and compare it to what your new monthly payment might be when you take on a debt consolidation loan if the new payment is less, then yes, you will have more money in your pocket each month. Thinking long-term if total loan costs are lower with a debt consolidation loan, you can also save money.
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