Debt Consolidation 101: Your Guide To Consolidating Debt

Consumer debt is at an all-time high, and the last two quarters of 2020 saw the total consumer debt of Americans grow to $14.88 trillion. Although that number is high enough by itself, it’s only half of the story, though. Here’s why.

The Changing Landscape Of Debt In The United States

In March 2020, the COVID-19 global pandemic rocked the world. As global quarantines became enacted, people all around the world lost their jobs, were unable to work, and faced extreme economic uncertainty. As you can imagine, this only served to increase borrowing as Americans needed extra money to cover living expenses and take care of their families.

This economic emergency led to the biggest increase in American consumer debt ever. The total consumer debt of Americans rose from $14 trillion at the beginning of 2020 to $14.88 trillion at the end of 2020. All in all, this was a 6% increase in the total amount of debt in just one year, which is the biggest increase that’s ever been recorded in a single year!

Although the economy has started to stabilize somewhat over the course of the past year, there’s still a long way to go and Americans are still more in debt than they’ve ever been before. With each passing month, more consumers are falling behind on their credit card debts, auto loans, home loans, and personal loans.

While debt collection was temporarily halted during the pandemic’s peak, collections are back in swing and many consumers are finding that their accounts have been passed into collections. Those who haven’t been passed to collections are constantly harassed by bill collectors who may even threaten them.

Thankfully, there’s a way out through obtaining a debt consolidation loan. These loans are able to consolidate multiple debts into a single monthly bill, get you back on track with your payments, and may even help boost your credit score!

In today’s article, we’re going to show you everything that you’ve ever wanted to know about debt consolidation loans, how they work, why you should consider them, how to apply to them, and even some similar alternatives that you can try instead.
You shouldn’t have to live under the burden of debt, and we want to show you that there’s a way out.

What Is A Debt Consolidation Loan?

So, what exactly is a debt consolidation loan?

In theory, it’s actually quite simple. A debt consolidation loan is a loan that you can apply for that will pay for your other loans. In this manner, your other loans become consolidated into a single loan that you can pay off in a timely and affordable manner.

Instead of having to pay off several different loans with different interest rates on several different dates (that are almost always inconvenient), you’ll essentially combine them all into a single low-interest loan that you can pay off with a single monthly payment. Your new consolidation loan will often feature a lower interest rate, a payment that you can actually afford, and may even help improve your credit by paying off your old debts all at once!

Personal Loans vs. Debt Consolidation Loans

So what’s the difference between a personal loan and a debt consolidation loan? If you know anything about loans, you’ve probably gathered that personal loans are loans issued by a bank or a lender designed to be used for a wide range of things. Personal loans could be used for:

  • Starting a business.
  • Going on vacation.
  • Covering an emergency home or auto repair.
  • Helping out a family member in need.
  • Helping you pay your bills if you’re out of work or between jobs.
  • Purchasing a recreational vehicle.
  • …and more!

Personal loans are typically given out based on your current financial standing (income level, assets, and expenses) and your credit score (which represents your trustworthiness as a borrower).

Although debt consolidation loans are designed to cover past debts, they’re technically considered a type of personal loan. Whenever you finish paying off your debt consolidation loan, it will be reported as an installment loan that’s been paid in full on your credit report.

The only difference between personal loans and debt consolidation loans is the application process. Typically, debt consolidation lenders will want to get a full picture of your debts owed to ensure that you’ll be able to make your payments on time. Additionally, debt consolidation loans may come with slightly lower interest rates due to the larger amount of the loan itself.

Why Apply For A Debt Consolidation Loan?

Still not convinced that a debt consolidation loan can help you manage your existing debts better? Well, here are some of the top reasons why you should consider consolidating your debt under the umbrella of a single debt consolidation loan.

No Collateral Necessary

One of the best reasons to apply for a debt consolidation loan over other forms of debt consolidation is that you don’t need any extra collateral. Collateral is something that some lenders require before giving you a loan. It could be your car, house, personal bank account, business, or even your investment assets. The idea behind collateral is that the lender has something valuable that they can take away from you to recoup their loss if you fail to pay.

However, traditional debt consolidation loans almost never require you to provide collateral to obtain your loan. This means that you won’t have to risk your home, sign over your vehicle title, or serve your business up to the lender. It can provide an added level of security and comfort, knowing that you’re not risking your most valuable possessions.

Fixed Repayment Date

Another great reason to consolidate your debt with a personal loan is that you’ll have a fixed repayment date. As soon as you’re given the loan, you’ll be given an exact schedule that includes every monthly payment you’ll need to make from the time you start making payments to the final day that the loan is paid off.

If you have unconsolidated loans that you’re still struggling to pay off, the chances are that all of the loans are for different amounts and that they all are due on different dates. You could have one loan that’s set to be paid off next year, another that won’t be paid off for two years, and another that still requires three more years of payments.

Once you secure your debt consolidation loan, you’ll be able to pay off all of your loans at once. You’ll be left to pay a single loan with a fixed repayment date, so you’ll know exactly when you’ll be out of debt.

Lower Interest Rates

Possibly the best reason to apply for a consolidation loan is that you’ll get a better interest rate since it’s a single loan. Let’s just say, for example, that you have three separate loans:

  • $5,000 loan at 15% APR ($750 per year in annual interest)
  • $10,000 loan at 8% APR ($800 per year in annual interest)
  • $4,000 loan at 6% APR ($240 per year in annual interest)

If you do the math, you’ll be paying $1,790 every single year in APR fees that do not go towards the principal of your balance.
Now, let’s just say that you apply for a debt consolidation loan of $19,000 to cover all three loans and simplify your payments. The lender gives you a 6% APR since your credit is decent and the total amount of the loan is a larger sum. At 6% APR on a $19,000 loan, you’ll only be paying $1,140 per year in interest fees, which is $650 less than what you were paying before.

It may seem incremental with this example, but the more money you owe, the bigger of a difference that it will make for your bottom line!

One Easy-To-Pay Bill

One of the most simplistic reasons why people apply for debt consolidation loans is to simplify their monthly payments. If you’re paying multiple loans to multiple different creditors, then it can sometimes be hard to keep up with your payments.
Perhaps you forget about one payment and then have to pay late fees or extra interest. Maybe your boss gives you your paycheck a few days later than expected, and you end up being late on your payment. Or, perhaps, you’re on vacation somewhere where there’s no internet or phone signal, and you miss payments for several bills.

Being locked into paying numerous debt installments can be tedious, annoying and can have you spending hours on the phone or visiting online payment portals trying to get your bills paid. That’s not even mentioning the additional fees that you’ll often have to pay for “processing fees.”

When you consolidate your loan into one easy-to-pay installment, you’ll only ever have to worry about making one payment once a month. If there are any transaction/processing fees to pay, you’ll only have a single processing fee to pay, not multiple.

No More Late Fees

According to a recent CNBC report, late fees and bank overdraft fees cost the average American around $250 every single year. This number can be a lot higher if you owe a more significant sum of money to multiple lenders. Again, the more installments you have to pay in a given month, the more likely you will miss a payment and find yourself paying annoying late fees.

With a consolidated loan, you’ll only have a single monthly payment to keep up with. While there will likely still be a late fee to pay if you neglect to make your payment on time, at least you’ll only be paying one late fee, not multiple.

Improve Your Credit Score

Last but not least, consolidating your debt into a single personal loan can actually help you boost your credit! If you’re applying for a consolidation loan in the first place, the chances are that you’ve already started to fall behind on your monthly payments and are struggling to keep up. You may have even had a few missed or late payments posted on your credit report that are starting to bring your FICO score down.

When you receive your consolidation loan, you’ll be able to pay off all of your installment loans in one fell swoop. This makes your credit look great and makes it look like you know how to manage your debt well. This, in turn, raises your credit.

Applying For A Debt Consolidation Loan: How Does It Work?

Hopefully, by now, we’ve got your attention and you’re starting to come around to the idea of consolidating your loans. While the approval process can sometimes be a bit tricky, it’s almost always worth the extra time invested into the application process. You’ll be able to start making payments on time, boost your credit, and will prevent future missed payments, late fees, and negative interest from accruing.
That being said, here’s how the process of applying for a debt consolidation loan typically works.

Analyze Your Debt

Your first step is to analyze your debt. Make a complete list of every debt you owe, how much longer you have to make payments, your interest rate, and the remaining principal on the balance.

You should try to categorize each loan by the amount you pay in installments and the APR. You’ll also want to identify which loans are the most troublesome. The ones that have higher interest rates, overly expensive installments, and the ones you’re falling behind on should take precedent. Most consumers don’t get a consolidation loan to cover all of their debts, just the ones that they’re having trouble keeping up with.

Lastly, you’ll want to review your credit reports (which can be done for free here) and your bureau credit scores. This will give you a good idea of your eligibility to be approved for a debt consolidation loan in the first place and what type of APR you can expect on the loan.

Find A Solid Lender

Once you figure out which installments you want to consolidate, it’s time to find a lender. Here’s where it pays to shop around a bit. Make a list of the top five lenders that you’re considering and give each of them a call to gauge how helpful and attentive the organization is. It’s also a good idea to read reviews on the lender from other consumers.
Every time you apply for a consolidation loan, the lender will perform a hard pull on your credit check, so minimizing the number of hard pulls on your credit by selecting the right lender is vital unless you want your credit score to drop receiving too many hard pulls.

Apply For Your Loan

Once you find the lender that’s right for you, it’s time to apply for your loan. To make the application go smoother, it’s a good idea to have all of your paperwork ready to go. If you receive paper statements, then collect all of the ones from the past few months. If you use online billing, make sure that you know your login credentials or download digital PDF reports of your statements.
The lender will usually also require you to provide proof of income and proof of residence, so make sure to bring pay stubs or be ready to show personal bank records to prove how much money you bring home every month.

Paying Your Loan Off

Once you secure the loan, your first step should be to pay your old creditors off first. Depending on the lender you’re working with, they may opt to pay your creditors directly to ensure that the funds are being directed in the right direction, though.

You’ll just need to make sure that you make your monthly loan installments on time from here on out. Since you only have a single installment payment each month, it should be a lot easier to budget your money to ensure that you never miss a single payment!

Will My Debt Consolidation Loan Improve My Credit?

A number of factors determine your credit score, and the heaviest element is your credit payment history. While obtaining a debt consolidation loan doesn’t guarantee that your credit will rise, there’s a high possibility that it will increase due to the fact that you are paying off numerous debts all at once.

What Debts Can I Consolidate?

The following debts can be consolidated with a traditional debt consolidation loan:

  • Credit cards (business credit cards, store credit cards, gas cards, personal credit cards).
  • Medical bills that that have gone into collection.
  • Unpaid child support and alimony.
  • Back taxes to the IRS or your local state government.
  • Personal loans obtained from other lenders.
  • Payday loans and title loans.
  • In-store loans (e.g., buying a tv or living room furniture).
  • Collections accounts.

As you can see, you can consolidate almost any type of debt.

What Debts Can’t I Consolidate?

However, there are some debts that you will not be able to consolidate. Mortgages, for instance, cannot be consolidated with a personal debt consolidation loan since they’re backed by collateral. You may also have trouble trying to consolidate auto loans unless you specifically work with a lender that specializes in consolidating auto loans.

Some lenders will only offer to help you consolidate private debts and won’t help you consolidate federal debts such as IRS taxes or federal student loans. However, this varies from one institution to another, depending on their lending policies and restrictions.

Tips For Getting A Debt Consolidation Loan

Before you go shopping for your next debt consolidation loan, here are some great tips to ensure that you get the best deal that works for you and your family.

Tip #1- Avoid High Fees

Try to avoid consolidation lenders who charge exorbitant fees or lenders who are asking you to pay a higher-than-average APR. High-APR consolidation loans can be just as expensive if not more expensive than your original debts, and should only be considered as a last option.

Tip #2- Pay It Off Quickly

Whenever possible, try to agree to the shortest repayment term possible. The quicker you pay off your consolidation loan, the less interest you’ll pay in the long term, and the faster you’ll be debt-free.

Tip #3- Manage Your Finances

If you’re living from paycheck to paycheck and have no extra money to spare, then a consolidation loan may actually hurt you. If you don’t have enough money to cover paying your monthly installments, then you’ll just have to take out more loans and end up in even more debt. Try to reduce your bills and cut costs so that you can make that extra payment (even if it means moving in with your family temporarily).

Tip #4- ALWAYS Read The Fine Print

This goes without saying, no matter what type of loan that you apply for. Although lenders are required by law to provide you with full disclosure, some lending agents can be a bit shady or forgetful about certain details in the contract. Make sure you ask questions and get every part of the fine print agreement explained in easy-to-understand terms.

Alternatives To Debt Consolidation Loans

If you’re denied for your debt consolidation loan, or you’re just interested in other options, here are some popular alternatives to consider.

Credit Card Balance Transfers

You can apply for a new credit card and then transfer the balance from your new card to pay off the debt on an old account. This can get you out of hot water, but make sure that you pay your new credit card off before it becomes a problem.

Cash-Out Your 401k

If you have a 401k from your job, you can cash out a small portion of it to cover emergency expenses (or impending collections). However, this can be risky, as you’ll be required to pay it back if you quit your job or you’re fired.

Borrow Against Your Life Insurance Policy

If you have a whole life policy, you can borrow some money from your policy. However, it’s best only to do this with small amounts, as you’ll be required to pay it back with interest.

Borrow Against Your Home

If you’ve paid off a significant portion of your mortgage or you own your home outright, then you can go to your bank and ask to borrow a loan by using your house as collateral. However, it’s essential to pay your loan back or you could lose your home!