What Is a Debt Consolidation Loan?
Debt consolidation is a common method of refinancing that involves paying off high-interest debt with a new lower-interest loan.
The consolidation loan is usually used to pay off multiple unsecured debts like personal loans, medical bills and credit cards. It allows the borrower to focus on making one payment on the new loan, rather than multiple payments.
Debt Consolidation Loan Example
Here is an example of how a debt consolidation loan can combine several lines of credit card debt into one monthly payment.
Let’s say you have 3 credit cards with a total balance of $15,000 and an average APR of 24%. If interest is compounded monthly you would need to pay $1005.00 a month for 24 months to bring the principal balance to zero. At the end of the repayment term, the total interest paid would be $9,126.56.
If this debt was consolidated at a lower interest rate, you could save money on interest and may also have a lower monthly payment.
Consolidation Loan #1: This loan would lower your monthly payment and would save you $3,917 on your total debt paid.
Consolidation Loan #2: This loan would keep your monthly payment the same and would save you $6,032 on your total debt paid.
|Details||Your Combined Credit Card Debt||Loan #1 (lower monthly payment)||Loan #2 (same monthly payment)|
|Bills Paid||3 payments||1 payment||1 payment|
|Terms||24 months||24 months||16 months|
Average Interest Rate of a Debt Consolidation Loan
A consolidation loan works best when you can get an interest rate that is lower than the interest rate on your existing debt. Keep in mind, when you apply for a loan your interest rate will depend on your credit score.
The average annual percentage rate (APR) on a debt consolidation loan is around 18%. However, it can range from 4% and 36% depending on your creditworthiness.
By comparison, the average APR on a credit card is 15.38% to 22.53%. If you drill down the results to credit cards for bad credit, the average climbs to 24.43%.
In order to determine if a consolidation loan is a good choice for you, you will need to determine what monthly payment you can afford.
Are Debt Consolidation Loans a Good Idea?
Debt Consolidation loans can be a successful debt relief strategy when certain criteria are met. These loans should never be used for additional spending and should only be used to pay off existing debt. Consolidating debt is a good idea if you are able to:
- Qualify for a loan with an interest rate lower than your existing debt
- Able to make payments on the consolidation loan
- Do not plan to take on new debt
Refinancing your debt with a consolidation loan should not result in more financial strife. Unfortunately, there are some behaviors and circumstances that can lead to financial failure in an effort to consolidate your debt.
Reasons Consolidation Loans Fail to Resolve Debt
- You spend money beyond your means
- Monthly payments are more than you can afford
- The interest rate on the loan is too high
- Your situation changes due to job loss or a medical emergency
- You take on a new debt too soon
Credit Card Debt Consolidation
Credit card consolidation works by combining all of your outstanding credit card balances into one monthly payment. This can be accomplished in a few ways:
- Balance transfer to a new credit card
- Taking out a personal loan to pay off card balances
- Working with a debt relief company on a credit card debt relief plan
Ideally, you should choose the consolidation method that allows you to secure the lowest possible interest rate or pay the least amount overall on your debt.
Medical Debt Consolidation
It’s very difficult to plan for medical expenses. When you receive care you may not know how much your insurance will cover until you receive bills from your service providers. Medical debt can easily become overwhelming because bills will arrive from many different service providers.
There are several ways to help lower your medical bills including advocating for more coverage from your insurance company, checking your bills for errors, as asking your providers for a discount or payment plan.
If you have exhausted these measures a debt consolidation loan can take your remaining medical debt, combine it and simplify your repayment plan.
Consolidation Loans for Bad Credit
Having good credit can make debt consolidation simpler, but you still have options if your score is less than perfect. There are generally three common ways to consolidate credit:
- Opening a new credit card and transferring your balances
- Taking out a debt consolidation loan
- Receiving a customized consolidation program through a debt relief company
While there are credit card and consolidation loan options designed for people with bad credit, it’s important to proceed with caution. You don’t want to end up with a new credit card or loan that has less favorable terms than what you currently have.
A Debt Relief Program Can Help
Working with a debt relief company to consolidate your debts could be a great option for you. At Accredited Debt Relief, we bring years of debt relief and financial service experience to every consultation. We will help you build a personalized debt settlement program and guide you through the process of taking back control of your finances.