Debt consolidation refers to taking a new loan to pay off other consumer debts and liabilities. In the process, multiple loans are condensed into a single loan, generally with better terms like lower interest rates, monthly payments, or both. This form of consolidation of loans can be used to deal with student loan debt, credit card debt, and other liabilities. Read on to learn more about debt consolidation loans and their advantages and disadvantages.

What are the different types of debt consolidation loans?
There are two different types of debt consolidation loans: secured and unsecured. Secured loans are backed by one of the borrower’s assets, such as their car, or house, as collateral for the loan. Unsecured loans are not backed by assets and can be more difficult to obtain. They may have higher interest rates and lower qualifying amounts.

In either case, the interest rates are generally lower than those charged on credit cards. The rates are also fixed generally, so they do not differ or fluctuate over the repayment period.

How are loans consolidated?
There are several ways to consolidate your loans into a single payment. The most common methods include:

Debt consolidation loans
Banks and personal lenders offer debt consolidation loans as a payment plan to borrowers with multiple debts. They are specifically designed for customers who want to repay multiple high-interest loans.

Credit cards
Previous credit card payments can all be consolidated into a new credit card, especially if the new one charges little or no interest in the initial phase. Another option is to use an existing card’s balance transfer feature if special promotions are offered on transactions.

HELOCs
Home equity loans or home equity lines of credit (HELOCs) can also be used as a debt consolidation method.

Student loan programs
The government offers consolidation options for people with student loans via the Federal Direct Loan Program, where the new interest rate is the weighted average of the previous loans.

How does debt consolidation work?
With debt consolidation, lenders can use different financing to pay off their debts and liabilities. The process involves consolidating the various debts into one loan/liability and then making payments until the new loan is paid off entirely. For most people, the first step of applying for a debt consolidation loan is through their bank, credit union, or credit card company. Others may choose to opt for private mortgage companies or lenders. A higher credit score will lead to the best possible interest rate to consolidate debts.

What are the advantages of debt consolidation loans?
Debt consolidation is an excellent option for people with multiple loans with high-interest rates or monthly payments. By negotiating for a debt consolidation loan, it is possible to cut down the monthly payments to just one (instead of multiple), along with a reduced interest rate.

What are the disadvantages of debt consolidation loans?
Although the interest rate and monthly payments may be lower on a debt consolidation loan, it is important to pay attention to the payment schedule. Consolidation may lead to a longer payment schedule, which means that the borrower will pay more in the long run. Before considering consolidation loans, please speak to your credit card company or bank advisors about how long it would take to pay off debts at the current interest rate and compare the same to the consolidated loan plan.

People with special provisions (like on student loans) may lose out on interest rate discounts and other rebates, so it is important to keep these details in mind before considering a consolidated loan.

How does debt consolidation impact credit scores?
Debt consolidation can help maintain credit scores. Paying off the principal amount sooner can keep interest payments low, so you pay less money out of your pocket each month. This can boost credit scores and make you an attractive borrower for future creditors.

On the other hand, consolidating existing debts into one single loan may negatively affect credit scores initially because they tend to favor long-standing debts with consistent payment histories.

What are the requirements for debt consolidation?
Borrowers must meet the income and credit score requirements to apply for a debt consolidation loan. These can be supported by documentation like the letter of employment, letters from creditors or repayment agencies, and two months’ statements for each credit card/loan you wish to pay off. However, the documents required would differ based on the borrower’s credit history.

The best personal loans for debt consolidation offer lower annual percentage rates (APRs) and flexible repayment terms. They also avoid prepayment penalties, helping you be debt-free early without paying an extra fee.