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What Is a Debt Consolidation Loan?

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This article was created with the help of AI technology, thoroughly edited by a member of our editorial staff, and vetted for accuracy by one of our fact-checkers.
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Tamara Altman
Dr. Altman has over 25 years of experience in social science, public health, and market research, statistics, evaluation, and reporting. She has held positions with, and consulted for, many government, academic, nonprofit, and corporate organizations, including The Pew Charitable Trusts, the National Park Foundation, Stanford University, UCSF, UC Berkeley, and UCLA.
Read time: 9 min
Updated on April 11, 2024
This debt-management solution could be an alternative to help you streamline your bills.

A debt consolidation loan is a low-interest loan used to pay off other high-interest debts. It’s intended to make payments easier and help borrowers get out of debt faster, which is something many Americans could use help with right now: Collective non-housing debt reached $4.13 trillion in the third quarter of 2020.

While many Americans used their stimulus checks to pay off debt, resulting in the first drop in balances in eight years, 43% of respondents reported taking on more debt than usual due to the pandemic. And more than a quarter of Americans said they’ve taken on at least $10,000 in new debt since the start of the pandemic.

About 38% of households that experienced a job loss have struggled to pay their bills, according to Pew, while most Americans who have kept their jobs have thrived financially during the pandemic due to a decrease in spending coupled with government stimulus checks.

Those struggling with debt may want to consider consolidating debt.

How does a debt consolidation loan work?

Here’s how a debt consolidation loan typically works:

  1. Apply for a personal loan equal to the total amount of outstanding high-interest debt you’ve accumulated.
  2. Use the cash to pay off credit cards, payday loans, and other debt.
  3. Repay the personal loan in monthly installments.

To benefit from a debt consolidation loan, you’ll need to get a loan with an APR that is lower than what you’re currently paying on your other debts.

Should I use a debt consolidation loan?

Generally, a debt consolidation loan can be a good idea if the following are true:

  • You can get a lower APR than what you’re currently paying
  • You can get a monthly payment that you can afford with your current income
  • Your total debt balance (besides your mortgage) is no greater than 40 percent of your gross annual income
  • You have a budgeting strategy in place to avoid accumulating more debt

For example, let’s say you have two credit cards with $5,000 balances: One with a 16.99% APR and another with a 24.99% APR. If you’re paying $250 per month on each of them, you’ll be out of debt in 2.1 years. But if you have good credit, you could take out a debt consolidation loan with an APR as low as 12%. That would mean you could be debt-free in 2 years and save more than $1,200 in interest. Plus, you’ll only have a single monthly payment to worry about, and it’ll be about $30 less than what you were paying before.

If you have bad credit and can’t qualify for a low-interest personal loan, debt consolidation may not work for you. The only exception is if you have high-interest payday loans, title loans, or pawn shop loans that you won’t be able to pay back on time. An installment loan may help you consolidate those debts and spread your payments over many months.

If you just have a small amount of debt that you can afford to repay over the next year, it’s probably not worth consolidating. Likewise, if you’re overwhelmed with debt, you may not be able to overcome it on your own. If you’re likely to default on the new loan, it would make more sense to seek credit counseling or pursue bankruptcy before that happens.

How to qualify for a debt consolidation loan

Lenders may assess your credit score, debt-to-income ratio, and employment history when determining if you are eligible for a debt consolidation loan. Some online loan lenders will also consider other factors, such as your education, which can make it easier to qualify if you have fair credit. Few lenders offer no-credit-check debt consolidation loans, and those that do charge much higher rates than other personal lenders.

How to compare debt consolidation loans

Every lender will weigh your credit and income information a little differently, so you may want to start the prequalification process with a few different lenders so you can compare their offerings. Prequalification won’t hurt your credit score. Once you know your options, consider the following factors when choosing a debt consolidation lender:


How much do you need to borrow? You’ll want to choose a loan that covers the full amount of your debt. Many personal lenders offer loans up to $35,000 or more, but the amount you qualify for will depend on your income, debt, and credit score.

Origination fee

While some excellent credit lenders don’t charge any fees, some lenders charge an origination fee, which is the cost of processing the loan. This can vary depending on your credit score and can cost anywhere from 1% to 10% of the loan amount. The amount is taken out of the cash you receive from the loan.


The APR represents the total cost of borrowing the cash, including the origination fee and interest rate. It tells you how much extra in addition to the principal you’ll need to repay. This is one of the most important factors to consider when comparing lenders.


The term of the loan, or the length of time you have for repayment, will impact your monthly payment. You should choose a loan with a long enough term that allows you to afford the monthly payment, but not such a long term that you end up paying excessive interest. Generally speaking, you shouldn’t agree to a loan with a term longer than five years.

Prepayment penalty

Some lenders charge a prepayment penalty to protect the amount of interest they receive for issuing the loan. That means you can’t make extra payments or get out of debt sooner without incurring a fee. You should avoid lenders that charge prepayment penalties unless they can offer a significantly lower APR.

How to repay a debt consolidation loan

If you take out a debt consolidation loan, you’ll typically save on your monthly payment, but you still need to ensure that payment fits into your budget. You should have a repayment strategy in place before you sign an agreement.

To start, reevaluate your budget. Add up all your household’s sources of income and subtract recurring bills such as rent or a mortgage. Allocate your remaining income to various spending categories such as groceries and utilities, based on what you’ve spent in past months. Look for areas to trim spending, like eliminating dining out, alcohol, or coffee. The more cash you can free up in your budget, the more you’ll have for debt repayment. If your emergency fund isn’t yet stocked, you should make sure to allocate a little cash towards savings every month as well, especially considering the current economic downturn.

To make payments easier on yourself, set up an automatic payment for your debt consolidation loan a few days after you are scheduled to receive your paycheck. That way, you’ll always make your payments on time and have enough funds. Any leftover cash from your income can be used to cover your expenses or boost your savings.

If you’re not finding areas to trim your budget and you can’t afford the monthly payment on a loan with a term of five years or less, you may need to secure additional income. You could get a second job, pick up a side hustle, seek government assistance, or ask for help from friends and family. Just make sure you have a plan for affording that monthly payment before you sign a loan agreement.

Debt consolidation loan alternatives

Balance transfer credit card

If you have good credit and debt that you can repay in 12-18 months, you could save a significant chunk of change by using a balance transfer credit card. These cards can come with a 0% introductory APR offer, so you won’t need to pay a cent of interest for up to 18 months once you transfer your debt balance. That means you can devote more of your income towards debt repayment and get out of debt faster. Just be aware that most credit cards can come with a balance transfer fee that’s usually around 3% to 5% of the balance. Do the math to make sure this form of debt consolidation is worth it for you.

Debt avalanche method

Sometimes, a good debt repayment strategy is all you need to expedite the repayment process. A fast and cheap way to get out of debt without a debt consolidation loan is to use the debt avalanche method. With this strategy, you’ll list your debts in order of highest APR. You’ll continue making the minimum payments on all your debts each month, but you’ll put any extra income towards paying down your highest interest debts first. Once your highest interest debt is paid, you’ll move on to the next.

Credit counseling

A nonprofit credit counseling organization such as the National Foundation for Credit Counseling can help you lower your interest rates and streamline your bills with a debt management plan. These organizations negotiate with your creditors to determine a payment plan that stops collection calls and often eliminates finance fees. You’ll make a single monthly payment to the nonprofit organization, which will handle paying off your debt.

Debt settlement

For-profit debt settlement companies attempt to settle your debt with your creditors for less than you actually owe. While it can save you money, the process comes with many drawbacks. For one, your creditors aren’t required to agree to negotiations with the debt settlement company, so it’s possible you could pay high fees and the company will be incapable of settling all of your debts. Furthermore, the debt settlement process can tank your credit. That’s because you’ll be asked to cease payment to your creditors while the debt settlement company negotiates. The FTC recommends researching debt settlement companies thoroughly and watching out for debt settlement scams. In most cases, credit counseling is a better option.


If other options won’t help you get out of debt and you’re in over your head, bankruptcy may be the only way out. But since bankruptcy stays on your credit report for seven to 10 years and makes it very difficult to access credit, it should only be considered as a last resort. Furthermore, though bankruptcy will alleviate your debt, legal fees can be expensive. There are nonprofits that offer free help with bankruptcy filing, however.

The bottom line on debt consolidation

Debt consolidation could be a great way to save money if you have the right amount of debt and can afford repayment on your debt consolidation loan. If you’re wondering whether you should consolidate your debt, a debt consolidation calculator can help you assess the timeline and cost savings.

If you feel overwhelmed by debt, it’s okay to ask for help from a credit counseling agency. You can discuss whether debt consolidation or a debt management plan is a better option for you before entering into an agreement.

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