Choosing A Debt Consolidation Lender

Debt consolidation involves combining multiple debts into a single account to reduce the number of bills you pay each month. Ideally, you’ll also lower the overall interest rate and pay off the debt more quickly.

If you’re considering a debt consolidation loan, it’s smart to first review your finances to see which method is the best for you. Take time to understand how debt consolidation works before applying.

6 factors to compare when choosing a debt consolidation lender

When choosing a debt consolidation lender, consider the type of loan, interest rates, fees and repayment options, among other features.

Type of loan

There are multiple debt consolidation options to choose from, each with its own pros and cons. Selecting the right type of financing is important as it will help guide the lender you choose.

While personal loans are most commonly used for debt consolidation, there are alternative options as well:

• Personal loans
  

  Many lenders offer personal loans designed to help you pay off debt faster and save on interest. These loans, often called debt consolidation loans, come with a fixed interest rate and set repayment term. The idea is to pay off your outstanding debt with the loan funds, and then make a single payment each month.

  Some personal loan lenders will repay your existing creditors directly to streamline the process and help you avoid the temptation of using the funds for other purposes.

• 0% APR credit cards
  

  Also known as balance transfer credit cards, these cards offer an interest-free introductory period, typically ranging from 12 to 21 months. They are generally reserved for consumers with good or excellent credit. Only consider this option if you’re certain you can pay off the new card during the introductory period. You’ll face typical credit card rates after, which can be steep.

• Home equity loans
  

  You can convert up to 85 percent of your property’s equity into cash and use it to consolidate debt with a home equity loan. It acts as a second mortgage with a repayment period of five to 30 years. The interest rate is also fixed and lower than most credit cards. However, a major drawback is that you could lose your home to foreclosure if you default on the loan.

• Home equity lines of credit
  

  A HELOC is like a home equity loan, but you won’t receive the loan proceeds in a lump sum — instead, the line works more like a credit card. You can pull funds as needed, up to a set limit, during the draw period, and interest only accrues on the funds you’ve withdrawn. Most HELOCs only require interest payments during this period, which may be as long as 10 years. Once it ends, you’ll repay the balance in monthly installments over a term of 10 to 20 years.

Approval requirements

As with all financial products, your credit score is a critical factor in your eligibility for a debt consolidation loan. Most lenders require good credit, or a FICO Score above 670. Lenders also set a maximum debt-to-income (DTI) ratio, commonly 36 percent.

While you may find a lender that permits a low credit score or a high DTI ratio, you’re unlikely to qualify for a low interest rate without a strong credit profile. And since the purpose of debt consolidation is to save money, improving your credit score and payment history before applying is key.

Loan amounts

Before choosing a debt consolidation lender, determine how much debt you have to consolidate. Check your debt balances and request payoff amounts from each creditor, which will be slightly higher than your current balance. Once you have this number for each debt you want to consolidate, you can look for a new lender.

Lenders cap the amount you can borrow. Make sure to check the max beforehand so you can consolidate all of your accounts with a single new one.

Interest rates

A lender’s lowest rate is typically reserved for borrowers with excellent credit. The higher your credit score, the lower your debt consolidation rate is likely to be. Debt consolidation makes sense when you can qualify for a lower rate on a personal loan than you’re currently paying on your existing debt.

Let’s say you have balances across several credit cards, each with an average interest rate of around 20 percent. If you can snag a 10 percent rate on a debt consolidation loan, you may save a significant amount on interest. But if your credit score needs work and you only qualify for a lender’s top-end rate of nearly 36 percent, debt consolidation could cost you more in the long run.

Fees

The most common fee associated with debt consolidation loans is an origination fee — this is an upfront fee some lenders charge to offset their administrative costs. Origination fees, which can be as much as 12 percent of your loan amount, are deducted from your loan funds before you receive them.

Not all lenders charge origination fees. If you qualify with one that does, you may need to borrow extra money to account for the fee. Late fees and insufficient funds or returned check fees are standard but avoidable by making timely payments.

Repayment options

One meaningful benefit of a debt consolidation is the set payoff date. If you’re just making the minimum monthly payment on your credit card balances, it can take many years (and much accumulated interest) before you’re debt-free. But debt consolidation loans have set repayment terms, typically between one and seven years.

While a long repayment term will yield a lower monthly payment, you’ll pay significantly more in interest over the life of the loan. It’s smart to choose the shortest loan term you can realistically afford to repay.

Current debt consolidation loan interest rates

A debt consolidation loan can provide a lower interest rate than most credit cards. According to Bankrate data, the average personal loan rate is a little over 12 percent, while credit card rates are typically above 20 percent. However, your interest rate will depend on your credit score — rates range from about 7 to 36 percent. If your credit score is fair or poor, you may see rates toward the top of the range.

Your credit score, debts and monthly income can influence the interest rate and terms of the loan. You will likely receive average rates with a FICO score of around 670. For the lowest rates, you often need a credit score between 720 and 850.

What to know before applying for a debt consolidation loan

Before you borrow a debt consolidation loan, understand the following:

• Your credit score will take a temporary hit. When you apply for a debt consolidation loan, a hard credit inquiry is added to your credit reports. As a result, your credit score may suffer a temporary ding, typically about five points.
• Crunch the numbers to ensure debt consolidation makes sense. Before you consolidate your debt, use a debt consolidation calculator to see if doing so will save you money.
• You may have to adjust your spending habits. If you wound up in debt because of bad spending habits, a debt consolidation loan will only be a temporary fix. To stay debt-free, you must adjust your behavior.

How to get a debt consolidation loan

If the numbers make sense, take the following steps to get a debt consolidation loan:

1. Check your credit. Knowing where your credit stands is a good place to start. Check your credit score through your bank or credit card issuer, and review your credit reports for errors via AnnualCreditReport.com.
2. Get prequalified. To get an idea of your eligibility and the rates you may qualify for, prequalify with multiple lenders. This process can help you narrow your sights on the best lender without damaging your credit.
3. Compare loan options. Compare rates, terms and fees from at least three to five lenders to find the debt consolidation loan that best matches your needs.
4. Submit a formal application. After you’ve found the right lender for you, submit a loan application. If you’re approved, some lenders can disburse funds the same business day.

Bottom line

The best debt consolidation lender is the one that offers you the lowest rate and most competitive terms. It may also offer special perks, like direct creditor repayment or rate discounts for enrolling in autopay or using funds to consolidate debt. Be sure to read online lender reviews as well. Before finalizing your choice, compare rates from multiple lenders and crunch the numbers to ensure debt consolidation makes sense for you.