Should I Consider Loan Consolidation?

Learn about what debt consolidation offers and its risks and rewards

Approved stamped on a loan application page with a $20 bill laying nearby

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Loan consolidation is when you use one larger loan to pay off several small loans in order to combine multiple debts into a single one with one monthly payment. The goal of loan consolidation is usually to simplify debt or get more favorable loan terms that result in lower monthly payments, such as lower interest rates.

If you have a large amount of debt, loan consolidation may offer a solution. But it's important to understand what loan consolidation offers and the risks it poses before rolling your debts into one.

Secured vs. Unsecured Consolidation Loans

To consolidate your loans, you'll need to take out a debt consolidation loan to help pay them off. There are two broad types of debt consolidations loans you can take out:

  • Secured: This type of loan requires some sort of collateral, such as your home. The lender can seize and sell that collateral to recover the money you owe if you fail to repay the loan. Secured loans include mortgages, home equity loans, and car loans.
  • Unsecured: An unsecured loan, such as a credit card, student loan, or signature loan, requires no collateral. But it can be harder to get because lenders view it as risky that they have no collateral to take in the event of loan default.

Pros and Cons of Loan Consolidation

While a debt consolidation loan can result in more favorable loan terms and more manageable payments, it can also leave you worse off financially if you're not careful.

Advantages of Loan Consolidation 

Many people consider loan consolidation because of its clear benefits:

  • Lower or fixed interest rates: You may be able to lock in a loan at a lower interest rate than your old loans offered, which will often reduce the interest charges over the life of the loan. Or, you might switch from a variable-rate to a fixed-rate loan that results in more predictable monthly payments. This strategy can be a particularly good option if interest rates are low now but are expected to rise.
  • Extended loan term: You may be able to lengthen the period of time over which you repay the loan, which can create room in your budget to spend on other essential expenses
  • Lower monthly payments: Both of the above changes in your loan terms can result in a lower monthly payment than your existing combined loan payments.

Be sure that loan consolidation is the most financially beneficial option for you, and don't just do it because it will be easier to have only one payment a month. Use a debt consolidation calculator to run the numbers and ensure that you will come out ahead financially with loan consolidation.

Risks of Loan Consolidation

There are a few notable drawbacks to keep in mind before you take out a debt consolidation loan:

  • Loss of collateral: A secured loan is risky because it is tied to a larger asset, such as your car or home. You risk losing that property if you default on the loan.
  • Higher interest rates or lifetime interest costs: You might not qualify for loan consolidation, which may result in a new loan with the same or potentially a higher interest rate than you get on your current loans. Even if you secure a lower interest rate, you'll likely pay more in financing charges over the life of the loan if you extend the loan term.
  • Fees: You may have to pay loan application and origination fees along with prepayment fees for paying off old loans too early. These costs can eat into and potentially exceed the savings of consolidating the loan.

Evaluate the lower monthly payment of a potential loan consolidation versus the lifetime loan costs. If you are facing a loan that costs less on a monthly basis but more over the life of the loan, you'll have to decide whether more manageable payments are worth the added loan costs.

Whether to Consolidate Your Loan

Your decision should come down to the type of loan you plan to consolidate and the loan type you intend to use to consolidate your debts.

Student Loan Consolidation

One common type of loan consolidation is student loan consolidation. This type of loan consolidation is beneficial because you will generally take out an unsecured loan that doesn't require you to put up—or potentially lose—collateral. In addition, a number of perks come with debt consolidation.

You can switch from a variable-rate loan to a fixed-rate student loan, which can result in more predictable monthly payments.

You also have the option of extending the life of the loan and thereby lowering the monthly payments. If you choose to do this, realize that it will increase the amount of interest that you pay over the life of the loan because you will be paying down the loan over a longer period (potentially up to 30 years).

If you decide to consolidate your federal student loans, consider doing so via the federal government rather than through a private loan servicer, such as a bank or credit union. Here's why: If you consolidate with a private loan, you'll lose consumer protections associated with federal loans, and you won't be eligible for income-driven repayment plans or student loan debt forgiveness programs. 

Other Types of Loans

You can also consolidate credit cards, car loans, or signature loans, the latter being a type of loan that you can qualify for by supplying your income, credit history, and a signature to the lender.

But before you consolidate these types of loans, particularly large loans, consider what you have to gain or lose from loan consolidation. If you have multiple credit card debts, for example, consolidation allows you to switch from paying several issuers to just one issuer with one monthly payment.

Moreover, if you use an unsecured loan, such as a signature loan, to consolidate debts, you don't have to use or potentially lose collateral, which makes loan consolidation less risky to you even if they're riskier for the lender. However, you might still pay fees, hurt your credit, or even face legal troubles with the lender if you miss payments.

In contrast, if you use a secured loan to consolidate multiple car loans or even to consolidate unsecured debt such as credit card debt, you risk losing the collateral that you had to put up to get the loan. You could even lose your home.

It's important to evaluate this risk to your property in light of the potential benefits of loan consolidation. If you expect to achieve substantial savings over time from consolidation, and you are financially stable, the risk of a default and the loss of collateral may be lower for you. But if you're not willing to take the risk, you might want to consolidate with an unsecured loan (if you can qualify for one), or even forgo loan consolidation.

Fixing Your Spending Behavior

What most people don't consider with loan consolidation is that it does not resolve the problematic spending habits that may have put you in debt in the first place. In fact, if you spend recklessly after taking out a debt consolidation loan, you could increase your credit card debt, which would make it more difficult to repay your debt consolidation loan and negate its benefits.

It's important to address those problems in order to change your financial situation whether you decide to pursue a loan consolidation or not. The first step is to set up a budget and stick to it in order to stop overspending. Only then will you be able to maximize the benefits of loan consolidation.

The Bottom Line

While loan consolidation can be a smart move, it's only beneficial long-term if you choose a loan with favorable terms, avoid loans that present undue risks, and change your habits so that you don't continue to rack up debt.

If you choose to get a debt consolidation loan, research the loan servicer and carefully review the loan terms before signing on the dotted line.

If you decide not to consolidate your loans, know that there are alternative ways to manage your debt, such as getting a balance transfer credit card or working with a non-profit credit counseling agency to put together a debt management plan.

Updated by Rachel Morgan Cautero.

Article Sources

  1. Federal Student Aid Office of the U.S. Department of Education. "What is Loan Consolidation?" Accessed Feb. 18, 2020.

  2. National Credit Union Administration. "Personal Loans: Secured vs. Unsecured." Accessed Feb. 18, 2020.

  3. Federal Student Aid Office of the U.S. Department of Education. "Consolidating Your Federal Education Loans Can Simplify Your Payments, but It Also Can Result in the Loss of Some Benefits." Accessed Feb. 18, 2020.

  4. Federal Student Aid Office of the U.S. Department of Education. "When It Comes to Paying for College, Career School, or Graduate School, Federal Student Loans Can Offer Several Advantages Over Private Student Loans." Accessed Feb. 18, 2020.

  5. Experian. "What Is a Signature Loan?" Accessed Feb. 18, 2020.

  6. Experian. "How to Consolidate Debt." Accessed Feb. 18, 2020.