Debt Consolidation Loans: How They Work and What to Look For

Paying off debt is the first step toward a healthy financial life. A debt consolidation loan (opens in a new tab) may help you take that step.

With a debt consolidation loan, a lender issues you a single personal loan that you use to pay off your other debts, such as medical bills or balances on high-interest credit cards. You’ll pay fixed, monthly installments to the lender for a set time period, typically two to five years. The interest rate you receive depends on your individual credit profile, and it usually does not change for the life of the loan.

If you’re having a hard time keeping up with multiple payments, it’s a strategy worth considering.

Taking out a personal loan is not the only way to simplify your finances (opens in a new tab), however, and it may be more expensive than other options. If you decide to take out a debt consolidation loan, look closely at the fees a lender will charge, what kind of support it offers (such as financial education or payment flexibility) and whether you can use a co-signer to get a lower interest rate.

Below are the kinds of lenders that make debt consolidation easier.

A loan vs. a credit card to consolidate debt

If your credit is good, you can apply for a 0% interest credit card, which could save you quite a bit of money if you pay off your debt within the promotional period. But a personal loan offers some advantages of its own.

The big advantage to a personal loan is that it forces you to pay off your debt over time. If you’re disciplined enough to pay off that low-rate card before the teaser rate expires, that’s one thing. If you’re not sure you can, though, the personal loan may be the better bet.

In addition, a personal loan may improve your credit score by moving credit-card debt over to the installment loan column. The way credit scores are figured, borrowers who use all or most of the available credit on their cards get hit with a significant penalty.

Why not to choose a personal loan

A personal loan to consolidate debt makes sense only if you receive a lower interest rate than you have on your existing debt or if it helps you pay off your debt faster. Otherwise, taking on a new loan to wipe out an old one is postponing the inevitable.

Personal loans also frequently carry origination fees, usually from 1% to 10% of the loan amount, though some lenders charge more. You may pay less by simply tackling your existing debts in a systematic way, rather than consolidating.

Lastly, the best rates for personal loans will go to those with impeccable credit. If you have limited credit history or a poor credit score, expect to pay rates at the higher end of the ranges shown.

Lenders that don’t charge an origination fee

As noted above, many online lenders charge an origination fee. The fee depends on your credit profile and is baked into the annual percentage rate (APR) (opens in a new tab) that you receive when you qualify for a loan.

If you’re already in the hole, every penny matters. Some lenders don’t charge an origination fee on their loans, have competitive rates and offer other advantages:

Some lenders stand out because they have no minimum credit score requirement and charge no fees, including for late or unsuccessful payments. They often have some of the lowest APR ranges on the market and let borrowers change their monthly payment amounts at any time, which can be helpful when you’re managing your cash flow to pay down debt. But they aren’t for borrowers on the ragged edge. These lenders typically approve those who have high incomes and are responsible with their finances, so if you’re in debt for being careless with your money, you may receive a higher interest rate or not qualify at all. In addition to the state of your credit, they may consider nontraditional data such as your college major and profession to make a loan decision.
Others have a modest minimum credit score requirement and provide next-day funding. They cater to those whose credit isn’t great, and they have competitive interest rates for those who are well qualified. If you fall behind on payments, they may charge a late fee, but that fee can sometimes be refunded if you make three consecutive on-time payments.
Some have no minimum credit score and offer large loans to borrowers with high incomes or earning potential. They offer low fixed and variable interest rates. Borrowers typically have solid credit histories and enough cash flow to cover their loan payments. If you are in a position to qualify for such a loan, you are also likely to qualify for a 0% interest card or a cheaper secured loan, so consider all your options to pay down debt.
Others set a higher minimum credit score and offer loans starting from a few thousand dollars, aimed at those who want to consolidate debt. Their borrowers tend to have high credit scores and high incomes, so they aren’t ideal for borrowers with bad credit. They often offer some flexibility around payment dates.

Lenders for financial discipline

Installment loans demand more discipline than credit cards. Some lenders take that discipline a step further: They accept only borrowers who are paying off credit card debt, set a minimum credit score and a maximum debt-to-income ratio, and charge an origination fee but no late fee. Each borrower is assigned a point person who will learn the customer’s financial habits and guide him or her out of credit card debt.

Lenders that allow co-signers

Some lenders are a smart choice if you have bad credit but also have people willing to help you pay down debt. They reward borrowers who have multiple sponsors on a loan by giving them lower rates or allowing them to borrow more money. Sponsors can back borrowers for as little as $100. The number and credit quality of sponsors determines the rate reduction or loan amount the borrower receives. Borrowers can keep adding sponsors during the life of the loan.

Other lenders typically allow a single co-signer.

Editorial note: Origination fees and rates vary widely by lender and credit profile; compare current offers before borrowing.