Managing multiple debts like credit card debts, personal loans, and other liabilities can be tedious. It can also quickly become stressful and pose a risk to your credit score and credit reports.

Learn how to avoid bad credit by combining all your loans with a debt consolidation loan and see how you might benefit. 

What are debt consolidation loans?

Debt consolidation loans, as the name implies, are used to consolidate all of your current debts into a single debt with monthly payments and, ideally, a lower interest rate.

These loans are helpful for people with a bad credit score or individuals who manage multiple debts at once. Let's understand how it works with an example. 

Mike is employed and uses three credit cards with a total outstanding credit card debt of $20,000. His average annual interest rate is 20% for each card.

To bring down his credit card debt to zero, Mike has to pay about $333.33 in interest each month for 12 months on a total of $2,000. 

If Mike takes a debt consolidation loan with a lower interest rate of 14%, the average monthly interest comes down to $233.33. Mike will have to pay $1,900 monthly for 12 months to bring the debt down to zero.

The $100 difference means $1,200 saved on total monthly payments over a year. 

Consumers with unmanageable credit card debts or any other unsecured loans can take advantage of debt consolidation loans.

How to qualify for consolidation loans

In general, accessibility to a debt consolidation loan is dependent on your creditworthiness and income standards.

The first thing lenders check before moving further with a loan application is your credit score and credit history. For basic eligibility, you must have a good or excellent credit score.

  • If your credit check reveals a fair credit score of 620 or more, you are likely to get a debt consolidation loan with reasonable loan rates. The higher your credit score, the more chances you have of getting lower interest rates. Some lenders also prefer a minimum credit score, so look out for the credit score requirements as well before applying.
  • The next factor lenders look at is the credit history of an individual. If you have a good credit record of paying your bills on time and no defaults on your previous loans, your chances of getting a debt consolidation loan significantly increase. Bad credit is an essential requirement for lenders to pre-qualify your loan application, so make your monthly loan payments on time and maintain a good credit score.
  • Another essential requirement is to have a reliable income source proving you can make the monthly payments on time. Having a job, a regular credit of money in your savings bank account, or an asset in your name will increase your chances. 
  • You can also pay off one or more of your existing debts to build a better credit utilization ratio on your credit report. For example, you can repay any small credit card debt or personal loan with your savings.

Tip: Apply for pre-qualification, which is a soft credit inquiry to check your credit score. An easy way to do this is to check your FICO credit score with online lenders to know if you have bad credit. It will not affect your credit score, unlike a hard credit inquiry made by financial institutions when they process your loan application.  

What to do if you don't qualify for a debt consolidation loan

You may find it challenging to qualify for debt consolidation loans if you have a bad credit history or have ever filed for bankruptcy. 

Here's what you can do about it: 

  • Wait for some time as you pay off and close some of your debts to improve your credit profile.
  • Look for lenders that offer debt consolidation loans in your credit score range. Plus, prefer fixed rates of interest and negotiate for lower rates.
  • Keep your debt-to-income ratio low, preferably at 35% or less. 
  • Consider adding a family member/friend with a good credit score as a co-signer. 
  • As a borrower, you can approach credit unions to take a debt consolidation loan at low-interest rates because they are nonprofit organizations.
  • Never fall for predatory loan schemes like payday loans or car title loans. 
  • Look for the best debt settlement programs if you cannot pay your outstanding loan amount. 

Advantages of debt consolidations loans

Here are a few advantages of taking debt consolidation loans:

Lower Interest Rates

If you find a suitable debt consolidation loan with a lower interest rate than the average of all your other loans combined. As a borrower, you will likely save significant money that would have otherwise been spent on interest payments. It can also expedite your debt repayment as you can allocate more budget towards paying off your loans. 

Financial and Mental Peace

Managing and paying different debt accounts each month can be a daunting task. Debt consolidation loans help bring all of it in one place, and all you have to worry about is making that one debt payment on the due date every month. 

Improve Your Credit Score

As you repay your debts with this new loan, they will be marked as paid on your credit reports. This will reduce your liabilities and also improve your credit score. 

Different types of debt consolidation loans

These are the types of loan options you can avail of for debt consolidation loans:

Debt Consolidation Loans

Some companies offer loans specially designed for debt consolidation. These are available at lower interest rates, and usually, the lender closes your consolidated debts with previous lenders on your behalf. 

If you have very bad credit you can look for a co-signer to support the credit report of your loan application process.

Personal Loan

These are unsecured debts usually given to employed people and can attract high-interest rates of up to 36%, depending upon your credit score and credit history.

Borrowers with a low credit score may find it challenging to obtain a personal loan.

However, suppose you tell your lender that you plan to use this money for debt consolidation. In that case, you can get customized loan offers with a suitable repayment schedule and low-interest rates. 

Balance Transfer Credit Cards

Some lenders offer BT credit cards that allow you to consolidate the outstanding credit card debt of all your cards into one. 

The good part with this plan is that the lender usually pays your outstanding credit card balances, and you don't have to do it individually. You can also have a zero-interest rate for some time due to promotional offers. 

Home Equity Loan

You can apply for a home equity loan if you own at least 15% of your property. You pledge your equity as collateral and get a lump-sum amount in return as secured debt loan funds. 

Factors to consider before consolidating loans

  • Do not use debt consolidation loans for small loan amounts. Something you can pay off within a year without financial distress is not apt for taking these loans. 
  • Ask for interest rate disclosure from lenders. Some companies offer attractive interest rates for a short period and only to a few borrowers.
  • Compare different lenders for annual percentage rates over the repayment term of your debt consolidation loan. Also, keep an eye out for origination fees.
  • Negotiate with your current lenders on loan terms for a lower interest rate. Additionally, you can just ask them for a debt consolidation loan rather than applying for a new one.
  • Ensure you have a steady source of income to handle the monthly payments. Think about a debt management plan and stick to it, and avoid late payments at all costs. Credit bureaus keep track of all your debt-related activities. You can activate autopay for all your monthly payments to avoid this and also any late fees.
  • If you have a bad credit score, wait and try to improve it. It will help you get a lower interest rate on the loan amount.

Alternatives to consolidation loans

Here are a few alternatives to debt consolidation loans:

Home Equity Lines of Credit

Also called HELOC, these are similar to home equity but you do not get funds as a lump sum. Instead, you'll have access to a credit line to use and can repay the money as you go.

401(k) Loans

You can use 401(k) loans to borrow money from your pension funds, as interest and fees tend to be lower. However, loan terms allow you to borrow only half of your vested amount and keep your job unless you repay this loan in full. 

Secured Loans

You can use a secured loan such as a mortgage debt to pay large debt consolidation loans. However, it poses a risk to your assets as collateral. 

If you have reached a point where you have bad credit, cannot cope with your debts anymore, and don’t have an option for a debt consolidation loan, look for debt relief programs.

These programs can help you come to terms with your lenders on a debt settlement, which can sometimes also lead to a debt consolidation loan. Additionally, you can take the help of a credit counseling professional for a debt management plan.