SAN JOSE, Calif.--(BUSINESS WIRE)--Managing multiple high-interest loans and credit card balances can make getting out of debt difficult, and a debt consolidation loan is one way to simplify the process.
A fixed-rate loan with a specific repayment term can be easier to deal with than the uncertainty of credit cards with revolving credit balances and variable rates. And by moving multiple balances to a new, lower-rate loan, you'll have fewer monthly payments and could pay less in interest overall.
However, you'll want to compare lenders and gather multiple loan offers before deciding to use a debt consolidation loan. Here are some educational tips on how to find and compare debt consolidation loans, from myFICO.
For more loan and credit education, visit myFICO’s blog at https://www.myfico.com/credit-education/blog.
Debt consolidation loans are personal loans by another name
You can use various types of loans and lines of credit to consolidate your debt, and there are pros and cons to each option. Debt consolidation loans are a popular choice, but they are actually a type of unsecured personal loan.
These loans can be a good fit for consolidating debts because they commonly share several key characteristics:
- A set repayment term. You can often choose from several repayment terms, such as three or five years, with corresponding interest rates and monthly payments. Once you choose the loan term, you'll know exactly how much your monthly payment will be and when you'll pay off the debt.
- Fixed interest rates. Personal loans also often have fixed interest rates, and the rate you receive could depend on your credit history, loan amount and repayment term. In contrast, credit cards have variable interest rates, which can rise or fall based on changing benchmark rates.
- Your eligibility depends on your credit history and financial information. The lender may consider your FICO® Score, income and outstanding debt payments when deciding whether to approve your application and your offer's terms. However, you don't have to offer the lender collateral for the loan.
Once you take out a debt consolidation loan, you'll repay that loan based on the terms you accept, which is why finding and comparing offers is important.
6 steps to find and compare debt consolidation loans
Although personal loans generally work the same way among different lenders, lenders may have different requirements and offer various loan amounts, interest rates and repayment plans. Comparing lenders and their loan offers is the best way to find the most favorable loan for consolidating debt. Here are six steps you can follow.
1. Figure out how much you want to borrow
Add up all the balances you want to consolidate to determine how much you need to borrow (check out this myFICO calculator, Should I consolidate my debts? to help you determine what makes sense). Keep in mind, some lenders charge an origination fee that gets taken out of the loan's proceeds. For example, if you accept a $5,000 loan and the lender has a 10% origination fee, you'll only receive $4,500.
2. Check your FICO® Scores
Your FICO® Scores can affect your eligibility for a personal loan and your loan offers. Check your FICO Score for free to see where you're at, and look into ways to improve your score before applying.
Some lenders list minimum credit score requirements, and a score in the high 500s to mid-600s is often high enough to qualify for a personal loan. However, a higher score could help you get better loan offers.
3. Compare lenders
You can find personal loans from online-only lenders, banks and credit unions. In addition to minimum FICO® Score requirements, you can compare several features to narrow down your list:
- Loan amounts. Make sure the lenders offer loans that match your desired loan amount because there are often minimum and maximum loan amounts.
- Loan fees. Origination fees can vary depending on your credit history and financial information, and some lenders don't charge any upfront fees. Other common fees include late payment and insufficient funds fees, which you can avoid by making your payments on time.
- Repayment terms. You may be able to choose from several repayment terms. A longer term lowers your monthly payment but leads to paying more overall interest. A shorter term can save you money, but you'll have a higher monthly payment.
4. Get preapproved
Once you find lenders that might be a good fit, see if you can get preapproved for a loan offer with a soft credit inquiry — a credit check that doesn't affect your FICO® Scores. A preapproval can be a good sign that you'll likely be approved, and you can compare the estimated loan amounts and repayment terms.
You can search for individual lenders that offer preapprovals, or use an aggregator service that allows you to enter your information once and get offers from multiple lenders. Aggregators and online comparison sites can help you save time, but they also make money by referring borrowers to lenders. Sometimes, these services only show you offers from their partnered lenders, which might not necessarily be as good as the offers you can get from other lenders on your own.
5. Apply and choose a loan offer
Once you've identified a top lender, complete and submit an official loan application. You may need to upload documents to verify your identity and income and will likely have to agree to a hard credit check. If you're approved, you might be able to compare several loan offers and choose the one that suits your financial situation best.
6. Pay down your existing debts
The lender issues the loan once you accept a loan offer and complete the final paperwork. Some lenders can send payments directly to your credit card issuers. Others will transfer the money directly to your bank account, and you will have to pay down the cards yourself.
In either case, make sure you monitor your credit card accounts for several billing cycles. You may need to pay off interest that accrued while you were consolidating your debt. Even missing a minimum payment for a small balance could lead to a late payment fee and hurt your FICO® Score.
Alternatives to debt consolidation loans
Using a personal loan to consolidate debt can be a smart strategy, and it might even help your FICO® Score. But it's not always the best option, and using a different approach to consolidate debt might make more sense.
For example, a credit card with a balance transfer offer might allow you to pay down your debt without accruing any interest. Or, working with a nonprofit credit counselor to get on a debt management plan could be helpful if you're struggling with credit card payments or overspending.
If you decide a debt consolidation loan is the way to go, make sure you check your FICO® Score and compare offers before taking out a new loan.
Get your FICO® Score from the people that make the FICO Scores, for free. Plus, free Equifax credit monitoring and a free Equifax credit report every month. No credit card required. For more information, visit https://www.myfico.com/products/fico-free-plan-a