The Truth About Personal Loans and Debt Consolidation

A recent study conducted by Pew Research revealed that 80% of Americans currently hold some form of debt. As consumer debt balances continue to rise, many individuals are seeking outside solutions to obtain financial relief. 

One method growing in popularity over recent years is using a personal loan to consolidate debt. While personal loans are typically thought of as a great option for financing home improvement projects, travel, and other large expenses, they can also be an effective way to manage outstanding balances, bills, and other debts. 

Knowing all the associated benefits and drawbacks of using a personal loan for debt consolidation will allow you to confidently move forward with a financial decision that’s right for you. 

What exactly is debt consolidation?

Debt consolidation is the process of taking multiple debts (typically higher-interest ones such as credit card debt) and consolidating their payments into one single fixed-rate monthly payment. This process often consists of using a personal loan to pay off your initial debts and then repaying your new loan in predetermined installments over a set term.

When should you consider a personal loan for debt consolidation?

Using a personal loan to consolidate debt is ideal for individuals carrying multiple high-interest balances on credit cards, medical bills, and other unsecured forms of debt.

What are the benefits of using a personal loan for debt consolidation?

Lowered Interest Rates:

The average personal loan has an interest rate of 9.41% APR—that’s less than half of the typical credit card rate, which currently averages 20.24% APR. For instance, if you have a credit card with a current balance of $5,000 and are just making minimum payments of $200, it will take you 12 years and over $3,000 in interest charges to pay off.  On the other hand, if you take out a personal loan with a 5-year fixed repayment term and use it to pay off the credit card balance, you would save over $2,500 in interest charges. 

While it also may sound enticing to transfer the balance over to another credit card with a low or 0% APR balance transfer, the introductory offers are temporary and subject to change after a period of time. With a personal loan, the interest rate remains fixed over the entire repayment term so you don’t have to worry about unwanted financial surprises, as long as you make your payments on time. 

Easier to Manage Payments:

Personal loans often make it easier to achieve on-time payments because you know upfront your fixed repayment amount and timeline. Many lenders typically have repayment periods anywhere from three to five years, allowing you to spread out your payments over a more manageable period of time without having to worry about accruing additional interest. 

Improved Credit Score:

One of the immediate benefits of using a personal loan to pay off credit card debt is that your consolidated accounts will now have a larger amount of available credit, resulting in a lower credit utilization ratio. Because credit utilization ratios make up 30% of your FICO credit score, by significantly reducing this ratio, you’ll see a noticeable improvement in your overall credit score.

What are the drawbacks of using a personal loan for debt consolidation?

Your Debt Remains the Same

Consolidating your credit card debt with a personal loan doesn’t reduce or forgive what you previously owed—it merely rolls everything into one streamlined payment. However, compared to other debt reduction methods like settlement or bankruptcy, your credit rating is protected and will increase as you repay your personal loan. 

Not all Lenders Are the Same

Before applying for a personal loan to consolidate debt, it’s essential to spend time researching your available options. Whether you decide to go through a traditional bank or an online lender, you’ll want to find a reputable lender that is upfront about their loan process. Knowing what to expect can help ensure you choose the right lender and loan that suits your financial needs. 

There could be upfront fees

Depending on your lender, there could be associated fees that come with your debt consolidation loan. Common fees include application, loan origination, balance transfer, closing costs, and annual fees. Before moving forward in taking out a personal loan, be sure to inquire about all potential fees. 

How can I be successful with debt consolidation?

Having the right mindset, personal motivation, and financial means available to repay your loan are all key elements that can help you succeed in your debt consolidation journey. Reflecting on what caused you to accumulate debt, to begin with, and addressing those issues can help create a successful path towards financial freedom. 

If you’re currently exploring the option of using a personal loan to consolidate debt, consider Credit Direct. At Credit Direct, applying for a personal loan is a quick and seamless process with funding as soon as 24 hours. Our application takes just minutes to complete with no effect to your credit score. With personal loans available up to $40,000, you can be sure to find the right solution for your financial needs.

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