Best Debt Consolidation Loans of 2022

Debt Consolidation Loan Costs to Consider

Debt consolidation loans come with the typical costs included with any personal loan, including:

• Interest: This is the extra you’ll repay on top of the amount you borrow. Debt consolidation loan rates could be as low as 3.5% or as high as 35.99%, depending mostly on your credit. Avoid loans with a higher interest rate than your existing debt unless consolidation feels like your only option to meet your financial goals.
• Origination fees: A lot of lenders charge a fee up front just for making you the loan. It’s usually charged as a percentage of the loan amount, around 2% or 3%, and it’s deducted from the initial funds you receive. If your lender charges an origination fee, take that into account to make sure you get the funds you need to cover your debt balances.
• Late fees: Some lenders charge a late fee if you make a payment past the monthly due date. The fee is typically a percentage of the payment due or a flat fee. Take note of these in your loan agreement if your financial situation changes and you’re unable to make payments on time. You might be able to avoid them by working with the lender to move your due date or ask for a deferment period.
• Prepayment penalties: Few lenders of debt consolidation loans charge these anymore, but double-check before you sign an agreement. Prepayment penalties are fees you owe if you repay ahead of schedule — either paying your loan balance off early or getting too far ahead on your monthly payments.

Debt Management vs. Consolidation vs. Refinancing

As you seek options to tackle your debt, you’ll probably come across information and services for debt management, debt consolidation and debt refinancing. They all have similar aims, but they’re not the same things.

• Debt management is a service offered by nonprofit organizations to get difficult debt under control. You work with a debt counselor to make arrangements with creditors, like adjusted repayment plans or reduced balances, and you make a single monthly payment to the organization, which pays creditors on your behalf.
• Debt consolidation is a personal loan or balance transfer credit card that replaces existing debt. You use a debt consolidation loan to pay outstanding balances, so you only owe money to a single lender each month, ideally with a lower interest rate or lower monthly payment.
• Debt refinancing is a way to take an existing loan and repackage it with different terms. Like consolidation, you basically replace one loan with another, but refinancing focuses on just one loan, rather than a plethora of debt accounts. You can often go back to your existing lender to ask for better terms — because, say, your credit has improved or the prime rate has gone down — or shop around for other offers.

Alternatives to Debt Consolidation Loans

Debt consolidation loans aren’t the only avenue for tackling your debt. Consider these other options and their effect on your credit score and financial goals before committing to a loan:

• Balance transfer cards: These credit cards let you transfer the outstanding balance of an existing card or several, so you pay it off to the new creditor. It’s a way for a credit card company to entice you away from a competitor. Balance transfer cards usually offer an interest-free period of about a year. If you expect to be able to repay your credit card debt within that period, this is a great way to save on interest. If you don’t repay within that period, though, back interest usually comes due, and your balance could become less manageable than you expected.

• Refinancing: If you have a single loan with unfavorable terms, you could return to the lender and ask to refinance. This could get you a lower interest rate or different monthly payment, depending on your financial situation and needs.

• Debt forgiveness: A debt management plan usually comes with some amount of forgiven debt, which could offer a tremendous amount of relief. You might also be able to negotiate a reduced repayment amount on your own directly with your creditors. This kind of settlement usually shows up on your credit report as a negative mark.

• Deferment: Check the terms of your existing debt to see if your lender offers deferment or other flexible repayment options. You may just need a month or two off of monthly payments or interest to get back on track, and that could save you the trouble of applying for a whole new loan.

What Is the Smartest Way to Consolidate Debt?

Two main options exist to consolidate credit card debt: a debt consolidation loan or a balance transfer card. Each has pros and cons, and which is best for you depends on your financial situation and goals.

A debt consolidation loan usually comes with a longer repayment period and a lower interest rate than a balance transfer card. The loan pays off your existing debts, and you just owe one monthly payment to the new lender. Ideally, you’ll lower your interest rate or monthly payment, depending on your goal.

A balance transfer card absorbs the balance of other credit cards and lets you continue to spend on the new balance. They often come with a year or so of no interest for the transferred balance, so this could be a strategic way to save money if you’re paying off debt fast. Back interest usually comes due at the end of the introductory period, though, so this becomes a costly option if you don’t pay your debt down fast.

A debt consolidation loan is probably a better option in most cases, because it sets you up for slower, steady debt payoff at a monthly payment you can manage and an interest rate that hopefully saves you money.

A balance transfer card is a smart strategy if you’re focused on quick debt payoff and are pretty certain you’ll eliminate your balance within the next 12 months. It can, however, be a risky move if you don’t have that solid plan in place to prioritize debt payoff for the near future.

How Does Debt Consolidation Affect Your Credit Score?

Debt consolidation could lower your credit utilization and create a positive line on your credit report, which could improve your credit score over time.

Here’s how it works:

• Credit utilization: Paying off your credit card debt — even if you take on a loan to do it — lowers the amount of your available credit you’re using, called your credit utilization. Lower utilization is better for your credit score.

• Credit report: Making your loan payments on time or ahead of time throughout the life of the loan creates a positive line on your credit report, which can help to balance any negative marks you’ve accumulated with unpaid credit card debt.

Debt consolidation could also impact your credit score negatively in these ways:

• New credit inquiry: When you apply for a loan, the lender does a hard credit inquiry, which shows up on your credit report as a request for credit. Your credit score will probably take a temporary dip because of that, but that effect doesn’t tend to last beyond a few months.

• Payment history: Paying your loan on time will be good for your credit score — but if you don’t make payments on time or you default on the debt consolidation loan, it’ll hang out on your credit report for about seven years and hurt your score.

How to Protect Your Credit When You Consolidate Debt

Debt consolidation can be a smart strategy as part of a plan to pay off your debt and improve your credit score. Replacing high-interest balances with a lower-interest loan is a smart step toward eliminating debt, which is good for your credit score.

But be careful not to make these common mistakes when you consolidate debt — they could end up hurting your credit score:

• Don’t close your paid accounts. Leave your credit card accounts open even after you pay off the balances. If you want to avoid using the cards again, cut up the physical cards, remove the virtual cards from your digital wallet and erase the card numbers from your browser. Keeping old accounts open ensures you have mature accounts in your credit history, and the unused balances help reduce your credit utilization.

• Don’t skip monthly payments. Plan ahead to take out a loan with monthly payments you expect to be able to absorb. If you’re coming up on a monthly payment you won’t make on time, contact the lender ASAP to negotiate a different due date, deferment or other flexible repayment option. Missing monthly payments dings your credit report and will certainly lower your score, in addition to racking you up more debt in fees and interest.

• Don’t add more credit card debt. If you can avoid it, don’t use credit cards while you repay your debt consolidation loan. Or use them with careful intention, and repay your purchases frequently (like, daily) to avoid carrying a new balance. This lets you concentrate on paying off just the one debt, so you can work toward financial relief.

Keep on Refinancing

You don’t have to stop after one debt consolidation loan.

After you’ve made on-time payments for a year or so, check your options again to see if you could refinance to even more favorable terms. Your positive payment history and reduced credit card debt can very likely improve your credit score and expand your options for better loans.

Knowing this is an option down the road could give you some relief now, too: You may need to take out a high-interest loan with a long repayment term because you have bad credit now. Consolidating your debt this way might be your best path to getting out from under a mountain of stressful and confusing debt. But you don’t have to stick with those terms forever.

As your credit score improves and your debt balance goes down, consider refinancing the loan in the future to get better terms that’ll save you money and help you reach your goals even faster.

Frequently Asked Questions (FAQs) About Debt Consolidation Loans

We’ve rounded up answers to some of the most commonly asked questions about debt consolidation loans.

Contributor Dana Miranda is a Certified Educator in Personal Finance® who has written about work and money for publications including Forbes, The New York Times, CNBC, Insider, NextAdvisor and Inc. Magazine. 

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