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How Do Debt Consolidation Loans Work

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Staying on top of multiple debts can be overwhelming, and keeping track of several bills and payments every month can be challenging. A debt consolidation loan could help you streamline the debt payoff process and save some money on interest along the way.

But before deciding, you might be wondering: what is a secured loan, and how does it compare to an unsecured loan for debt consolidation? Here’s a closer look at how debt consolidation works and the types of loans that might work for you.

What is a debt consolidation loan?

A debt consolidation loan allows you to roll several debts, typically with high interest, into a single loan with one easy-to-manage payment. You can typically consolidate debt like:

  • Student loans
  • Credit cards
  • Medical debt
  • Personal loans

You may be able to consolidate other types of debt depending on the lender, so it’s best to research and ask questions before you apply.

You can apply for a secured or unsecured loan to help you consolidate your debt.

Secured loans

Secured loans are backed with something of value that you own, called collateral, like a house or vehicle. If a borrower defaults on a secured loan, the lender has the right to take possession of the collateral to recover the amount owed.

Unsecured loans

An unsecured loan does not require collateral. Instead, the lender will typically approve a loan application based on the borrower’s credit history and ability to repay. Since no collateral is involved, unsecured loans often come with higher interest rates than secured loans.

Pros of a debt consolidation loan

The greatest advantages of a debt consolidation loan include the following:

  • One monthly payment: You’ll no longer have to make multiple payments on several debts, which can make your life easier and help reduce the risk of missed or late payments.
  • Lower your interest rate: If you qualify for a lower interest rate than the rates you have on your current debts, a debt consolidation loan may save you a lot of money. You can put the savings toward your emergency fund or other financial goals. But this also means consolidating your debt can extend your loan term, leading to higher total interest paid.
  • A set repayment schedule: If you take out a debt consolidation loan, you’ll know exactly when to repay your debt. This can keep you motivated and on track.

Cons of a Debt Consolidation Loan

Just like any loan or line of credit, a debt consolidation loan has some drawbacks, including:

  • Fees: Unfortunately, debt consolidation loans aren’t free. Depending on the lender, you might have to pay fees in addition to interest, like origination fees and application fees.
  • A potentially higher rate: You may not qualify for a lower interest rate depending on your creditworthiness and the lender’s requirements.
  • Can lead to more debt: If you fall behind on your payments or use your credit cards while still paying on a debt consolidation loan, you could end up in a cycle of debt again. It’s also important to understand why you are in debt now so it doesn’t happen again.

The Bottom Line

A debt consolidation loan can be a powerful financial tool if you use it responsibly. If you’re ready to get out of debt, it’s certainly worth exploring. It may be just what you need to become debt free and improve your finances.

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