Personal loans for debt consolidation make a lot of sense on paper.
Say you have $20,000 of outstanding debt, which is all credit card debt. On average you pay a 14% interest rate for that debt.
If you were to take out a personal loan at 10%, payoff the above debt, then focus on repaying the personal loan–you’d save 4% interest a year on $20,000. Which roughly works out to be $800 a year (the math is a bit more complicated).
That’s $800 a year that can go towards repaying that debt.
That’s a big win right there.
But do personal loans for debt consolidation always make sense?
Let’s dig in…
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Personal Loans For Debt Consolidation | A Good Idea?
What Is A Personal Loan For Debt Consolidation?
A debt consolidation loan allows you to combine (consolidate) multiple existing loans into one new one.
The goal is to do so at a lower interest rate, thus saving money. You can learn more about the different ways to consolidate debt in this article.
When Is A Personal Loan For Debt Consolidation A Good Idea?
If you can find a lower interest rate–a personal loan makes a lot of sense.
When it comes to debt, you always want to pay the lowest interest rate. If a personal loan allows you to do that–it’s often a smart thing to do.
When are personal loans a bad idea?
Keep in mind personal loans don’t fix underlying bad financial habits. In other words, a personal loan isn’t a magic pill.
With any goal in life–you want to focus your efforts on the biggest bang for your buck.
Consolidating your debt can only do so much.
Many individuals searching for personal loans are much better off cutting expenses first.
- Read: 100+ Ways To Save Money
Cutting out a gym membership, saving money on food, and driving less can cut hundreds from your monthly budget.
In most cases, this is much more savings then a personal loan can provide. I’d argue most are better off spending 2-3 months on cutting expenses and increasing income. In turn, this can improve your credit score, which will allow you to qualify for a better rate.
Only after you’ve shown some commitment–move forward with a personal loan for debt consolidation.
Options For Personal Loans For Debt Consolidation
If you think you’re ready to move forward with a personal loan, i.e. you’ve committed to changing your habits, it’s important to understand your options.
Your goal is to pay the lowest interest rate possible.
Important Note: Why is the goal not to minimize payments each month? For example, taking out a personal loan so only $350 a month is going towards debt repayment and not $450?
The reason is you want to pay this debt off as fast as possible. While consolidating frees up cash flow–you don’t want to do so at the expense of increasing the total amount of money paid over the lifetime of the loan.
As personal loans still have high interest rates–paying off this loan has to be a priority. Minimizing interest rate allows more money to go towards principal repayment and will save you money overtime.
Let’s go over a few options, along with the pros and cons for consolidating your debts:
Friends or Family
If you have the option–borrowing money from friends or family may be the best way to consolidate your loans.
There’s a lot to process with doing so (e.g. who can you go to, how will it impact your relationship). Nonetheless, it can make sense as friends and family are often willing to provide fair terms.
0% Balance Transfer Cards
Another avenue of securing a personal loan is through a 0% balance transfer card.
The advantage here is with a good card with no transfer fees, you can save a lot of money.
What’s extra important though to keep in mind is that you want to pay off the entire balance of the loan before the 0% rate expires.
This is why it’s vital to get your financial life together before opening such a card.
Traditional Banks & Lenders
Traditional banks are more then willing to lend you money. Often at fair rates — so this is another solid option to check out.
A fast way to find out what type of rate you qualify for is to use Credible.
Credible is to personal loans as Kayak is to the travel industry. It will help match you with the right lender to meet your needs.
P2P lending is another avenue to seek a consolidation loan.
Your potential for savings is heavily based on your credit score. Check to see what you qualify for at LendingClub.
The final option for refinancing loans is to use your home equity.
This option, available for homeowners with equity in their home, can often provide the lowest interest rate.
Keep in mind though this is a secured loan. So, you’re putting up your home as collateral.
If you have credit debt at high interest rates and can’t get a personal loan, another option might be Tally, an app that offers a line of credit specifically designed to reduce the amount of interest you’ll pay. Our in-depth review of the service runs down the specifics and shows you exactly how much you could save if approved.