4 Types of Debt Consolidation Loans
A debt consolidation loan allows you to combine all your debts into a single, lower interest rate loan. It is particularly beneficial when you have high-interest rates debts. Combining your debts this way allows you to lower your monthly payment and makes it easier for you to afford your monthly bills. There are several different types of loans you can use to consolidate your debt.
Home Equity Loan
A home equity loan is a loan that's taken out using the equity in your home as collateral. Equity is the market value of your house less any outstanding mortgage. You typically must have a fair amount of equity in your home and good credit to qualify for a home equity loan.
While the interest rates are typically lower than other types of loans, the drawback is that your home is now on the line for your credit card and other accumulated debt. If the payments become unaffordable, you face foreclosure on your home. Because of that, it's generally not a good idea to use a home equity loan as a debt consolidation loan.
Credit Card Balance Transfers
With a credit card balance transfer, you transfer balances due on one or several credit cards onto just one card. Ideally, you do this with a card that has a low-interest rate. However, you should be aware that low balance transfer interest rates are typically promotional rates that expire after a minimum of six months.
If you choose to transfer balances, make sure you know when the low rate will expire and what the eventual, regular interest rate will be after the promotional timeframe expires. If you want to use a credit card balance transfer as a debt consolidation loan, you'll need a credit card with a large enough credit limit to hold all your credit card debt.
There could be a downside to consolidating debt with a balance transfer—a hit to your credit score. Putting too much debt on one credit card could have a negative impact on your credit score as your credit utilization goes up. The good news is that your credit score will rebound as you pay down the balance.
Personal Loans for Consolidation
Personal loans can be used as debt consolidation loans if you can borrow a loan large enough to cover all your balances. A personal loan is an unsecured loan that has fixed payments over a fixed period of time. Once you're approved for a personal loan, you can use it to consolidate your debts.
Depending on your credit rating, you could have trouble getting approved for a personal loan. If you have bad credit, you may be approved, but at a higher interest rate, or you may not be approved at all. Taking a high-interest rate personal would let you combine your balances, but you may not save money in the long run.
Debt consolidation loans are offered by banks and credit unions for the sole purpose of combining your debts. Debt consolidation loans vary, so it's important that you choose wisely. Debt consolidation loans ideally have a lower interest rate than the rates you're currently paying. Be aware that sometimes the lower monthly payment is achieved by increasing the repayment period. It could mean that you pay more interest overall because of the longer repayment timeline.
Choosing a Loan Type
Know that with any type of debt consolidation loan, you're not getting rid of your debt. Instead, you're simply shuffling it around so that it becomes easier to pay. You'll feel like you have less debt and may be tempted to borrow more. Practice discipline and avoid borrowing until after your debt consolidation loan has been completely repaid. Even then, it's important that use good judgment in taking on additional debt.