How to use a personal loan for debt consolidation

Using a personal loan to consolidate your debts can help you organize your finances and even reduce the overall costs of your repayments. Find out how debt consolidation with a personal loan works, and if it’s the right option for you.

What is debt consolidation using a personal loan?

Debt consolidation with a personal loan involves using a new personal loan to pay off multiple existing debts, leaving you with just one repayment. 

You can consolidate most unsecured debts, such as credit cards and certain personal loans. Once those balances are paid off, you manage one schedule of payments, with terms set by the new loan agreement.

When to use a personal loan to consolidate debt

A personal loan can be a good option for debt consolidation when it simplifies your repayment schedule and reduces your interest payments. 

A personal loan could be worth considering for debt consolidation if:

• You can qualify for a rate that is lower than the average rate on the debts you plan to pay off.
• You want a fixed repayment term with a clear end date, rather than open-ended revolving balances.
• Your current debts have multiple due dates, and simplifying to one payment would help you stay on top of your finances.
• You can comfortably afford the new monthly payment and still cover your essentials.
• You plan to avoid taking on new debt after paying off your existing accounts.

When not to use a personal loan to consolidate debt

A personal loan can simplify your repayment, but it may not be worth it if it increases your overall cost or stretches your budget too far. 

In some situations, consolidation can even make debt harder to manage. Here are some signs that a personal loan might not be the best solution:

• The interest rate you are offered is higher than the rates on your current debts.
• Fees, such as origination charges or prepayment penalties on existing loans, would offset any potential savings.
• You need a long-term plan to make the monthly payment affordable, which increases the total interest cost.
• You only have a small amount of debt that you could pay off quickly without consolidating.
• You are likely to continue to use credit cards, which can leave you with the loan balance plus new card debt. 

How to consolidate debt with a personal loan

Step 1: Gather your debt details

Before you apply, get a clear picture of what you owe and the costs of your debt each month. This will help you determine how much you need to borrow and understand whether consolidation will improve your financial situation. Note the following for each debt:

• Current balance
• Annual Percentage Rate (APR)
• Minimum monthly payment
• Due date
• Payoff amount (if available)

Request payoff quotes from your lenders, as the amount needed to close an account may be slightly higher than the current balance due to accrued daily interest or fees.

Step 2: Work out the right loan amount and term

Your aim is to borrow enough to pay off the debts you are consolidating, without borrowing more that would increase your costs. You need to consider:

• What you are consolidating: Focus on high-interest debts or debts you struggle to manage. You do not have to consolidate everything if it makes the payment too high.
• Your loan term: A shorter term usually means higher monthly payments but lower total interest. A longer term can make payments easier to manage, but you may pay more interest overall.

Try to choose a loan term that keeps the payment affordable while still helping you pay off debt more quickly and cost-effectively.

Step 3: Apply for a personal loan

Once you know the amount and term you are aiming for, you can start comparing lenders and applying for a loan. Approval and rates often depend on factors like your credit report, income, debt-to-income ratio, and banking history.

When comparing loans, look beyond the monthly payment and check:

• APR
• Fees, such as origination or late fees
• Total repayment amount over the term

The offer with the lowest payment is not always the most cost-effective option if the term is significantly longer.

Step 4: Use the loan to pay off your debts

After you receive the funds, pay off the debts you want to consolidate as soon as possible. To stay organized, you should:

• Pay each account in full
• Keep confirmation numbers or receipts for each payment
• Check each account afterwards to confirm the balance shows $0
• If clearing credit cards, ensure any regular payments from the card are stopped and close the account

If you are paying creditors yourself rather than the lender paying them directly, try not to use the money for anything else.

Step 5: Stay on top of your repayments

Consolidation only works if you keep up with your new payments and avoid building new debt alongside it. A few habits can help:

• Set up autopay or reminders so you do not miss due dates
• Keep a buffer in your checking account to avoid overdrafts
• Avoid using paid-off credit cards unless you have a plan to pay the balance in full
• Track your progress monthly so you can see your balance going down

If you think you might struggle to make your loan payments, call your lender as soon as possible to discuss your options.

Alternatives to personal loans for debt consolidation

A personal loan is not the only way to simplify or reduce debt. If the rate you’re offered is not competitive, or the payment does not fit your budget, one of these options may be a better fit.

• Balance transfer credit card: This can be a good way to consolidate credit card debt, often with a promotional 0% interest period. However, transfer fees may apply, and you will need a good credit score to get the best deals.
• Debt management plan: A credit counseling agency may help you set up a structured repayment plan and negotiate terms with creditors.
• Negotiate with creditors: Some lenders may offer hardship programs, reduced interest, or payment arrangements if you’re struggling.
• Using savings: If you have emergency savings, paying down high-interest balances can reduce costs and lower the amount you need to borrow.

Mistakes to avoid when consolidating debt

Debt consolidation can be an effective way to manage debt, but a few common mistakes could make it more expensive:

• Borrowing more than you need: Taking extra funds increases your total cost and can delay clearing your debts.
• Choosing a longer term to lower the payment: A lower payment can be helpful, but a longer term often means paying more interest overall.
• Not paying off the old balances right away: Consolidation only works if the old debts are cleared straight away and in full.
• Ignoring fees and total repayment cost: Comparing only the monthly payment can hide a higher APR or extra fees.
• Spending on credit cards again: If you use credit cards after paying them off, you can end up with the personal loan balance plus new credit card debt.
• Missing payments after consolidating: A single missed payment can result in fees and damage to your credit score.