If paying off debt is your goal, debt consolidation with a personal loan could help you tame multiple accounts at once by channeling them into one monthly bill.
Let’s face it: Making payments to multiple lenders each month can be a hassle. It can also be expensive — especially if some of your debts have a high interest rate. Taking out a personal loan to consolidate debt can sometimes make debt repayment easier and cheaper.
That’s because a consolidated loan may have a lower interest rate than the combined rates on the individual loans and credit card debt you owe.
You can consolidate all different kinds of debt using a personal loan. But first, you’ll want to figure out if it’s your best option.
There are several ways to consolidate debt:
Personal loans
Personal loans can come from banks, credit unions, building societies or online lenders.
You can use the money for a wide range of purposes for a wide range of purposes, including repaying existing debt. Your interest rate will be based on your credit scores, income and other financial details.
You’ll know your repayment timeline upfront, and many lenders have repayment periods from one to five years. Many personal loans are unsecured, which means there is no collateral guaranteeing the loan.
Balance transfer credit cards
Balance transfer cards often have a limited time 0% promotional interest rate that allows you to pay no interest for a few billing cycles during the introductory period. You may have to pay a small fee to transfer the balance, although some cards do not charge for this.
Credit card providers determine the amount you can transfer to a balance transfer card based on your credit line and the creditor’s policies. Finally, remember that interest rates can be high when the promotional rate expires. And if you miss a payment during the 0% promotional period, the promotion will end. So try to keep on top of your payment schedule.
Equity release mortgage on your home
If you’re a homeowner with equity in your home, you could borrow against the house and consolidate your debt using an equity release.
Equity release mortgages on your home require you use the property as collateral to secure the loan. This means if you can’t pay back your loan, you could lose your home.
Pros of debt consolidation with a personal loan
There are several benefits to using a personal loan to consolidate debt.
You could reduce your interest rate
Personal loans can have lower rates than other kinds of debt. If you can qualify for a low-interest personal loan and reduce your rate, you’ll save yourself money on loan repayment.
You could lock in a low rate
Sometimes when you borrow money, your interest rate is variable. This means that the interest rate may go up or down during the term of the loan.
If you’re tired of owing money at variable rates, you could get a fixed-rate loan so you’ll know exactly what your monthly payment will be each month.
You will have a repayment timeline
When you take out a personal loan, you agree to repay that loan on a set schedule specified in your loan agreement. Since you’ll have your loan term going in, you’ll know exactly when you’ll become debt-free if you pay on time.
Be aware that if you want to pay off your loan early, your lender may charge an early repayment fee.
You could boost your credit
Your credit scores are based on a number of different factors, each with a different weight. For instance, if you’re unable to pay your credit cards on time, that can negatively affect your payment history — an important factor.
If you’ve maxed out your cards, that can hurt your credit utilisation rate. Credit utilisation measures the amount of your available credit you use. A lower utilisation rate could help your credit scores.
Consolidating your debt with a personal loan could help your credit scores if it leads to a lower credit utilisation rate and more on-time payments.
Cons of debt consolidation with a personal loan
There are some potential disadvantages to consider before you decide to use a personal loan to consolidate your debt.
You may pay a higher rate
There’s no guarantee a personal loan will definitely have a lower interest rate than all the debt you pay off. If you consolidate any debt with a lower interest rate, you’ll raise the costs of repaying it. You could use a debt repayment calculator to compare any potential savings.
You could end up paying more interest
Even if you lower your interest rate, there’s a chance your personal loan could cost you more if you stretch out your repayment period for too long.
If you use a personal loan with a five-year repayment term when you’d otherwise have repaid the debt in two years, you’ll pay interest for three years longer. This could mean you’ll pay more interest over time, depending on your loan’s interest rate.
You could get hit with fees
Sometimes you have to pay to take out a personal loan. Depending upon your lender, you could end up owing arrangement fees or early repayment fees if you pay off your loan early.
These fees sometimes make consolidating your debt more costly than just continuing to pay back your current lenders.
You might put assets at risk
Some personal loans are secured personal loans. With a secured loan, certain assets will act as collateral to guarantee the loan.
Lenders could take the collateral if you don’t repay as promised. If you take out a secured personal loan to consolidate debt that was unsecured — meaning the debt didn’t have any assets guaranteeing it — you’ve put the collateral at risk.
If you don’t pay back your loan, you could lose the property you put on the line.
You could end up deeper in debt
When you pay off credit cards using the proceeds of a personal loan, you free up your line of credit. If you use these cards again and can’t pay off the balance, you could end up owing your original credit card providers again.
But now you’d have to pay off your consolidation loan and a bunch of new debt, leaving you in worse shape.
Bottom line
Consolidating debt with a personal loan can be a good idea if you can get a new loan with favourable terms and a lower interest rate than current debt. Whether you can qualify for a consolidation loan depends on your credit scores, income and other financial factors.
If you qualify, make sure you understand the loan terms, have a plan to pay it back and get your spending under control so you don’t end up deeper in debt. If the conditions are right, a debt consolidation loan can be a good tool to help you become debt free faster.