If you have debts with multiple creditors and struggle to keep track of what you owe, a debt consolidation loan can offer simplicity and peace of mind. This type of loan allows you to combine your debts into a single monthly payment.
Before taking this step, make sure you understand the pros and cons that come with a debt consolidation loan. A loan could be tough for you to get with bad credit, but you can take steps to improve your odds.
[Read: Best Debt Consolidation Loans.]
What Is a Debt Consolidation Loan?
A debt consolidation loan allows you to funnel your debts into a single personal loan. This means you have just one payment for your debts and eliminate the stress of managing multiple bills.
In some cases, a debt consolidation loan can also lower the interest rate you pay, helping you save money and wipe out your debts faster.
“A debt consolidation loan is one tool you can use to get a handle on debt,” says Jeff Arevalo, financial wellness expert at GreenPath Financial Wellness, a national nonprofit credit counselor.
Pros and Cons of a Debt Consolidation Loan
Pros:
— You simplify your finances. A debt consolidation loan reduces the number of payments to make and due dates to track. You’re less likely to pay late or miss a payment and incur penalties and fees. “It’s easier to keep track of debt repayment when you see it all on one bill,” says Cynthia Meyer, a fee-only certified financial planner with Real Life Planning in Gladstone, New Jersey.
— You might have lower interest costs. In many cases, the interest rate on a debt consolidation loan will be lower than the rates on some or all of the debts you held previously. “If someone has been struggling to make their monthly payments, having a lower interest rate may result in a lower monthly payment, making it more affordable,” Arevalo says.
— You could improve your credit score. Paying off revolving lines of credit can lower your credit utilization ratio, giving your credit score a boost. Consistently making your debt consolidation loan payments can also help your score.
Cons:
— You may have to pay upfront fees. “Most loans require an upfront origination fee,” Arevalo says. “Some may require transfer fees.”
— You could end up with a “teaser” rate. That means the loan starts with a lower interest rate for a fixed period of time and then later increases to a higher rate.
— You could have higher overall costs. In some cases, a debt consolidation loan extends your repayment period. This can lower your monthly payment but, over time, “You may pay more in interest overall,” Arevalo says.
— You won’t always fix your financial problems. If you have a history of living beyond your means, you may fall back into bad habits. “If you consolidate debt but keep the credit cards open without changing the behavior that created the debt, you may run up more credit card debt,” Meyer says. “Then, you have a consolidation loan plus credit card debt again.”
[READ: Best Bad Credit Loans. ]
What Credit Score Is Needed for a Debt Consolidation Loan?
If you have fair credit or better, you may be able to get approved for a debt consolidation loan. That’s a score of at least 580 on the FICO scale. But even if you qualify for a loan with less than perfect credit, you might decide it’s not a good idea.
That’s because you could end up with a higher interest rate than what you are paying on revolving balances. “If your credit is not optimal, you’re more likely to qualify for loans with a higher interest rate,” Arevalo says.
The only way to know for sure whether a debt consolidation loan makes sense for your financial situation is to shop around and see what type of deal you can get.
Where to Get a Debt Consolidation Loan for Bad Credit
You have a number of options for finding a debt consolidation loan for bad credit, including:
— Local banks and credit unions.
— Lenders in your credit band. (Check minimum credit requirements.)
How to Qualify for a Debt Consolidation Loan With Bad Credit
Getting a debt consolidation loan when you have bad credit can be difficult but not impossible. Here are some ways to improve your odds:
— Check your credit score. Knowing your score will give you an idea of which loans could work for you. You might also review your credit reports — you can still get free weekly online reports from all three credit bureaus — to identify ways of improving your credit.
— Comparison shop and prequalify. Compare terms offered by a variety of lenders before applying for a debt consolidation loan. Search for lenders that allow you to prequalify to gauge your loan eligibility and interest rates with no hit to your credit score.
— Branch out. Local credit unions and some online lenders may offer flexibility with loan requirements if you have struggled with credit.
— Consider a co-signer. Applying with a co-signer who has solid credit and income could help you qualify for a loan you otherwise couldn’t get on your own.
Tips for Comparing Debt Consolidation Loans for Bad Credit
Comparison shopping is especially important to make sure you get the best deal on a debt consolidation loan with bad credit.
Have a good plan before you shop, Arevalo urges. “Determine exactly how much you need so that you’re not taking on too much,” he says. “Ensure you can make timely payments and repay the loan.”
Get multiple quotes, and seek lenders that offer prequalification with a soft inquiry that won’t hurt your credit score.
Review loan terms carefully to check for hidden fees that could cost you money: Don’t skip the fine print. You’ll also want to do the math to make sure the loan will save you money before you apply.
Watch out for predatory lenders and scams. Avoid companies that promise to get you a loan for an upfront fee. Payday loans are also not a good idea for debt consolidation because their sky-high annual percentage rates, or APR, and short repayment terms can put borrowers deeper in debt.
You can check whether you are working with a legitimate lender by making sure the business is registered in your state. Contact your state attorney general or banking or financial services regulator to find out.
Are Debt Consolidation Loans Bad for Your Credit?
A debt consolidation loan can temporarily hurt your credit but lead to long-term gains.
The hard credit inquiry when you apply for the loan and the new account, which lenders may view as a risk, can cause a short-term drop in your credit score. A new account lowers your average account age — and your credit score — but the effect is larger if you don’t have much credit history.
Your credit score may be helped if a debt consolidation loan lowers your credit utilization ratio — the percentage of available credit you’re using — or improves your payment history.
“Being approved for a debt consolidation loan is generally positive,” Meyer says. “If you pay off high-interest debt and other bills but don’t run up new balances, this will reduce your credit utilization score.”
Making your debt consolidation loan payments on time also can boost your score. Payment history is the most important factor of your FICO score, making up 35%.
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What to Do if You Can’t Qualify for a Debt Consolidation Loan
In some cases, your application for a debt consolidation loan might not be approved.
The lender will explain to you in writing why your loan application was rejected. Sometimes, this can provide clues about what you can fix to get a loan approved.
You could also see if another bank or credit union will grant you a loan. Each lender has its own criteria for deciding which loans to approve, and you might have more success with another lender.
Even if you can’t qualify now, you might have better luck a little later. If you continue to pay your bills on time and do not add to your debt, your credit score should improve.
“Look at your income and debt-to-income ratio,” Arevalo says. “Perhaps it’s best to wait and improve your credit.”
[Read: Best Personal Loans.]
Alternatives to Consolidating Debt With Bad Credit
A personal loan isn’t the only way to pay down your debt. If you have bad credit, consider these alternatives to debt consolidation loans:
Adjust your budget. If you don’t have one, create a budget. Revisit and adjust your budget as needed. You could try a budgeting app to help you track and rein in spending.
Negotiate interest rates. Contact each card issuer separately and ask for a lower interest rate. Your odds of succeeding increase if you have a positive payment history, Arevalo says. “If your credit is less than optimal, consider building up your credit before making the request,” he says.
Make more cash. Find a way to generate extra cash and use those funds to pay down your debt. “Take a second job or start a side hustle,” Meyer says.
Look into a balance transfer credit card. You could try to transfer debt to a card with an introductory 0% APR of at least 12 months. That will buy you time to pay off the debt without interest. But you will need good credit — a FICO score of at least 670 — to qualify, and you may not be able to transfer everything you owe and pay it off before the interest-free period expires. Also, some cards charge fees of 3% to 5% of the amount transferred.
Tap into your home equity. You could use a home equity loan or line of credit for debt consolidation, but that can be a risky strategy. “This is a secured loan, and if you default, you could lose your home to foreclosure,” Arevalo says.
Evaluate cash out refinancing. If it makes sense, you could refinance your mortgage and take some of the equity in cash. Your home serves as collateral for the loan, though, and you could lose it if you can’t keep up with payments.
Enroll in a debt management plan. Nonprofit credit counselors help you create a plan to repay your creditors with a single monthly payment over three to five years. Plans can reduce interest rates and improve your credit over time, but some creditors may not participate.
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How to Get a Debt Consolidation Loan With Bad Credit originally appeared on usnews.com
Update 04/21/23:
