What Is a Debt Consolidation Loan?

Consumers use a debt consolidation loan to consolidate or combine multiple debts into one. The debt consolidation loan can merge credit cards, medical bills and other types of debt. Getting approved for a debt consolidation loan typically hinges on your credit scores and income. 

Debt Consolidation Loan Defined

What is a debt consolidation loan? A debt consolidation loan is financing with a singular purpose: consolidating debts. When you get a debt consolidation loan, you typically borrow a lump sum of money. Your lender transfers a lump sum to you when you close your loan, and you use it to pay off other loans. Consolidating should give you a lower payment, lower interest rate, or both. 

The kinds of debts you could combine using a consolidation loan include:

• Credit cards

• Medical bills

• Personal loan for debt consolidation

• Auto loans 

• Private student loans

You can consolidate almost any kind of debt that has less-favorable terms than the debt consolidation loan. Most consumers consolidate unsecured debt.

A debt consolidation loan can be secured or unsecured. Whether you have a secured or unsecured debt consolidation loan, the lender can charge interest and fees. The interest rates, fees and the time frame you have to pay back a debt consolidation loan can depend on the type of loan. 

Types of Debt Consolidation Loans

There are several types of debt consolidation loans, including these five ways to consolidate debts:

• Home equity loan

• Home equity line of credit (HELOC)

• Cash-out refinancing

• Personal loan for debt consolidation

• Balance transfer credit cards

A home equity loan is a loan against your home's equity. Your equity represents what percentage of the home you (and not your mortgage lender) own. You can quickly calculate home equity by subtracting what you owe on your mortgage from the home's estimated value. 

Home equity loans usually have fixed interest rates, and you can pay them back over five to 30 years. The amount you can borrow with a home equity loan to consolidate debt depends on how much equity you have, your credit scores, and your income. 

A home equity line of credit (HELOC) borrows against your home's equity. It's a line of credit, not a loan. You can write checks from your credit line to pay debts, then pay back the HELOC with interest. HELOCs have variable interest rates that can go up or down over time.

Cash-out refinancing is a form of mortgage refinancing in which you take out a new home loan and draw out your equity in cash. A cash-out refi is often used to fund home repairs or improvements, but you could also use the money to pay off and consolidate debt. 

A personal loan delivers a lump sum of money you can use for various purposes, including debt consolidation. Depending on where you decide to apply for a personal loan, you may be able to borrow anywhere from $5,000 to $100,000 to consolidate debt. Personal loans typically have fixed interest rates and repayment terms lasting one to over ten years. 

A credit card balance transfer allows you to consolidate high-interest credit card debt by moving balances from one card to another. You open a balance transfer credit card, which has a low or 0% APR. You'd then transfer balances to the card and make payments. Almost all balance transfer cards charge a balance transfer fee.

What Is the Best Debt Consolidation Loan?

The best debt consolidation loan for you is going to be the one that allows you to consolidate all of your debts at repayment terms that suit your budget. 

The goal of debt consolidation is to simplify and streamline debt repayment and get better loan terms. Debt consolidation can help you pay less interest, depending on which loan you choose. 

Home equity loans and home equity lines of credit could be attractive for borrowing larger amounts if you've built up a decent amount of equity in the home. A home equity loan offers the advantage of a fixed interest rate with predictable monthly payments. On the other hand, with a HELOC, you only pay interest on the portion of your credit line you use.

Cash-out refinancing can supply cash to consolidate debts at low, fixed interest rates. However, cash-out refinancing is expensive and not the best debt consolidation option for most people. The main caveat with a cash-out refi, home equity loan or home equity line of credit is that your property secures the loan. If you can't repay what you've borrowed, you could risk losing the home. 

Personal loans for debt consolidation may be a good option if you have a good credit score and need to borrow less than $100,000. The better your credit score, the lower your interest rate will be. You can, however, still get personal loans for debt consolidation with bad credit. The rate you pay may be higher, so it's important to consider whether this option could save you any money. 

Finally, balance transfer credit cards can help you consolidate debt at a 0% APR. If you'd like to pay off debts interest-free, that's a good thing. However, you do have to consider how long the promotional rate will last. If you still owe a balance once the introductory rate ends, you'll have to pay interest on whatever remains at the card's regular variable APR. 

How Do I Get a Debt Consolidation Loan?

Many lenders offer debt consolidation loan options. If you own a home and are considering a home equity loan, HELOC or cash-out refinance, you might talk to your current mortgage lender first. Your lender can tell you what you qualify to borrow and estimate your interest rate.

If you're looking for a personal debt consolidation loan, you can visit individual personal loan lenders online or start your search at a marketplace. Debt consolidation loan marketplaces allow you to compare rates and terms from different lenders. If you see a loan option that appeals to you, you can then take the next step and apply. 

When comparing debt consolidation loan options, remember to pay attention to:

• Interest rates

• Fees, including origination fees and prepayment penalties

• Closing costs if you're considering a home equity loan, HELOC or cash-out refinance loan

• Loan repayment terms

With credit card balance transfer offers, you'd want to look at the APR you'll pay, how long that rate will last and the balance transfer fee. If you're considering a card that offers a 0% APR transfer for 18 months, it helps to think about whether that's enough time to pay off the balance before the regular rate kicks in. 

If you've evaluated all the debt consolidation loan options and can't find a suitable solution, there are other possibilities for managing debt. For example, you could seek debt relief through a debt management plan (DMP) or debt settlement. 

With a debt management plan, you make one monthly payment to a credit counselor or debt relief company. That payment is then distributed among your creditors until your debts are paid off. A debt management plan could save you money if your credit counselor or debt relief company can negotiate a lower interest rate or fee waivers on your behalf. 

Debt settlement allows you to pay off debts for less than you owe. You could try to settle debts alone, but it may be helpful to work with a debt settlement company. The company can work with your creditors to reach an agreement with your creditors. The debt settlement process can take time, but it can be an excellent alternative to filing bankruptcy.