What is a debt consolidation loan? Plus, your best options in 2022

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Stanley tate

Student Loan Lawyer

$400M+ student loans managed

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If you have multiple sources of debt that you want to consolidate, you can get a debt consolidation loan. These loans allow you to pay a single monthly payment and easily track your debt.

To qualify for a debt consolidation loan, you’ll need a good credit score and debt-to-income ratio.

I don’t often recommend standard debt consolidation loans to my clients with significant student loan debt.

For student loan debt, you should instead consider a student refinance loan or a Direct Consolidation loan. Both of these types of debt-combining loans typically offer better interest rates than standard debt consolidation loans.

Want to know more about living with debt, particularly student debt. Sign up for my email newsletter — it’s full of handy tips and tricks to navigating debt.

Now, let’s talk more about debt consolidation.

Disclaimer: Although I am a student loan lawyer, this article contains general information and should not be taken as legal advice. If you want legal advice that pertains to your specific situation, you should schedule a free consultation with me. Also, I recommend some products with affiliate links in this post, but rest assured that they’re ones I’ve seen work over years of experience as a student loan lawyer.

What is a debt consolidation loan?

Sometimes called a credit card consolidation loan, a debt consolidation loan is a personal loan that combines multiple high-interest debts into one loan with one monthly payment. Ideally, this loan will offer a lower interest rate than you currently have on the separate debts.

How does a debt consolidation loan work? A debt consolidation loan works by paying off existing debt and wrapping multiple debts into a single loan with a single monthly payment. You want to find the lowest rates, reducing the total money you pay long-term.

The most typical form of debt to consolidate is high-interest credit card debt, but you can also go this route to consolidate medical bills, payday loans, etc.

In many cases, debt consolidation should positively impact your credit score over time.

What is the purpose of a debt consolidation loan? The purpose of a debt consolidation loan is to simplify your finances, save you money, and (usually) boost your credit score.

A popular alternative to a debt consolidation loan is a 0% interest balance-transfer credit card. In many cases, multiple debts can be transferred to a new credit card that offers you a 0% interest rate on unpaid credit card balances for months — sometimes years!

Other alternatives to debt consolidation loans include:

  • Home equity loan
  • Credit counseling
  • Debt settlement companies

What is the difference between a debt consolidation loan and a debt management plan? The difference is that the consolidation loan opens new credit to deal with old debt. The management plan organizes your current financial situation to make repayment work where you are now.

Benefits of debt consolidation loans

The main advantages of getting a debt consolidation loan are lower interest rates and a single fixed monthly payment. Other benefits include that you’ll:

  • Find lower interest rates — A big reason to consolidate your debt is to find a lower personal loan rate. Lower rates mean you pay less money over the life of the loan.
  • Simplify your finances — Another significant benefit of consolidating debt is transforming multiple debts into one loan that’s easier to manage, track, and pay off.
  • Get a fixed repayment schedule — Many people prefer monthly payments to be the same every month. A debt consolidation loan can turn several variable credit card debt payments into a fixed monthly payment, further simplifying your finances.
  • Boost your credit score — In many cases, debt consolidation can boost your credit score overall. Although you will take a minor hit because of the hard credit check required for your application, a debt consolidation loan should increase your available credit and decrease your credit utilization.
  • Pay off your debt sooner — With the lower interest rates, fixed monthly payments, and simpler finances, you should be able to pay off your debt sooner if you get a good debt consolidation loan.

Disadvantages of debt consolidation loans

Why is debt consolidation a bad idea? Debt consolidation may be a bad idea if you have a low credit score or if you think a new loan will fix underlying bad habits that led to debts in the first place.

Here’s the truth about debt consolidation.

  • It doesn’t fix financial habits. Although a debt consolidation loan can reduce the amount of money you have to pay, consolidating your debt by itself cannot fix bad financial practices that led to debt accrual.
  • It may saddle you with extra fees. Various lenders may charge additional fees like origination fees, balance transfer fees, closing costs, prepayment penalties, and annual fees. Make sure you know the actual cost of each debt consolidation loan.
  • It could raise your interest rate. A huge reason to consolidate your debt is to lower your interest. But if your credit score is too low, you might not be able to find a good interest rate for a new loan. Don’t consolidate your debt if you can’t get a better interest rate.
  • It might negatively impact your credit score. Your credit score should improve in the long term, even though a hard credit check will slightly lower your credit in the short term. However, if a consolidation loan pays off specific types of debt, you might close certain lines of credit, which is not good for credit utilization or the average age of your credit. (For instance, if a debt consolidation loan pays off your car loan, that line of credit goes away, which is not so good for your credit. On the other hand, if you’re paying off credit cards with a debt consolidation loan, you’re fine because credit cards don’t close when you pay them off.)

How to qualify

Every loan lender has different qualifying requirements for a debt consolidation loan. Here’s what these lenders generally look for:

  • Credit score of 650 or more
  • Debt-to-income (DTI) ratio under 45%
  • Minimum loan amount

Most lending institutions want to see a credit score of at least 650. If you have a lower credit score, you might find a loan at a high interest rate.

Most lenders want potential borrowers to have a debt-to-income (DTI) ratio under 45%.

If you fall short in either of these areas, consider a cosigner who will boost the credit score and DTI ratio on the application.

Also, some lenders require a minimum loan amount for eligibility.

To see if you qualify for a specific debt consolidation loan, you usually have to go through the loan application process, or at least get pre-approved with a soft credit check.

Who can get a debt consolidation loan? Anyone with certain types of debt can apply for a debt consolidation loan. An excellent credit profile and low DTI help you get the best debt consolidation loans, but a few lenders do not require good creditworthiness.

Best debt consolidation loan lenders

  • Best overall debt consolidation loan: SoFi
  • Best for next-day loan funding: Discover
  • Best for okay credit: Upgrade
  • Best for consumers with little credit history: Upstart
  • Best for high-dollar loans and longer repayment terms: LightStream

Want more details on consolidating or refinancing your debt with SoFi? Read my extensive write-up on SoFi loan refinancing for student loan borrowers.

Do banks offer consolidation loans? Yes, some banks and credit unions may offer debt consolidation loans or 0%-interest balance-transfer credit cards. However, banks seldom offer the best loan terms compared to lenders who specialize in personal consolidation loans.

Is debt consolidation a good idea for student loans?

No, debt consolidation is not a good idea for student loans in most cases.

If you want to combine federal student loans into one loan, consider a Direct Consolidation loan. This lets you maintain your federal loan benefits, such as income-based repayment and forgiven loan options.

If your private student loan interest rates are too high, look for a lower interest rate. Even then, combine your private student loans into one lower-interest refinance loan with one monthly payment.

Options for federal student loan repayment

For federal student loans, refinancing should not be your first option. Instead, consider these options for federal student loan repayment:

  • Consolidation — A Direct Consolidation Loan consolidates multiple federal student loans (not Parent Plus loans), offering one single payment every month, but not a lower interest rate.
  • ForgivenessPSLF and other loan forgiveness programs are available to federal student loan borrowers.
  • Deferment — Request a deferment from payment (max 3 years) if you can’t make payments. If you have a Direct Subsidized or Perkins loan, interest will not accrue during the deferment.
  • Forbearance — During times of financial stress or other circumstances, forbearance can grant you reduced payments, maybe even $0 payments for a time.
  • Rehab — If you defaulted on your federal student loan, the government offers student loan rehabilitation to pull yourself out of default with 9 on-time payments. Completion of “rehab” removes the default from your credit report.
  • SettlementFederal student loan settlements are very uncommon, but possible in a few cases. If you want to try, you have to default on your loans (which will tank your credit) then shield yourself from wage garnishment. Even then, it’s unusual to settle for less than 90%-95% of the remaining loan amount.

Read my article on Forbearance vs. Deferment for a refresher on these two common options.

Options for private student loan repayment

There are fewer options available for private student loan repayment, but these two options are not bad:

  • Refinancing — You can refinance private student loans to get a lower interest rate and one monthly payment.
  • Settlement — If you default on your private student loan, you may be able to settle the debt for 50%-70% of the total loan balance. Private student loan settlement is one of my specialties; schedule a call to see how I can help.

Best lenders for refinancing student loans

Below are my six favorite lenders for student refinance loans:

  • CommonBond: Generous forbearance periods; Fixed-rate APR 2.59-6.74%; Variable rate APR 2.49-6.84% (APR means annual percentage rate.)
  • SoFi: Job search assistance and career planning, but no cosigner option; Fixed APR 2.74-6.94%; Variable APR 2.25-6.59%
  • LendKey: Generous forbearance periods; Fixed APR 2.95-7.63%; Variable APR 1.90-5.25%
  • Earnest: Option to skip one loan payment every 12 months without due date late fees; Fixed APR 2.50-5.79%; Variable APR 1.88-5.64%
  • Brazos: Parent Plus loans are eligible; Fixed APR 2.15-3.97%; Variable APR 1.87-4.79%
  • EDvestinU: No degree required; Fixed APR 3.91-6.28%; Variable APR 1.81-4.18%

All interest rates already show any autopay discount you can get if you enroll in bank account autopay.

For more info, check out my article on How to Refinance Student Loans + Best Lenders.

Not sure how to deal with payments?

If you don’t know how to deal with monthly payments or get loan approval, you might benefit from speaking with a bona fide attorney. Schedule a free 10-minute call with me to figure out if I can help you with my years of legal experience, particularly in the realm of student debt.

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Hey, I’m Tate.

I'm a student loan lawyer that helps people like you with their federal and private student loans wherever they live.

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