How does a debt consolidation loan work?
In short
A consolidation loan is one new loan that pays off several existing balances, leaving a single payment at one interest rate. It does not reduce what you owe; it reorganises it. Whether you qualify, and at what rate, depends entirely on the lender's assessment of your credit and income.
Updated
Who will a lender consider?
Lenders generally look for someone still current on their payments with enough income and credit standing to service a new loan. Missed payments and a high credit-utilisation ratio both work against an application.
Why can a lower payment cost more?
A lower monthly payment usually comes from a longer term. Stretching the same balance over more months means more interest in total even at a lower rate. Compare the total cost of credit, not just the payment.
What is the common trap?
The cards paid off by the loan are not closed by it. If the balances build again, you carry both the loan and the new card debt. Closing or freezing the accounts is the part people skip.
Frequently asked questions
- Does consolidating hurt my credit?
- A loan application produces a hard inquiry, and opening a new account changes the shape of your file. Whether the overall effect is positive or negative depends on your existing file and on what happens to the paid-off accounts.
- What if no lender will approve me?
- That is common and it is useful information rather than a dead end: it usually means the balances are large relative to income, which is the situation the other routes exist for.
- Is a home equity loan the same thing?
- No. Borrowing against your home converts unsecured debt into secured debt. The rate is usually lower, but the house becomes the security, which is a materially different risk. Weigh that carefully with the lender.