What is a Debt Consolidation Loan?
A debt consolidation loan is one that is issued to you to pay off all of your other debts in full, canceling all of the principals and interest spread across credit cards and student loans to condense it all into one channel, with one lower interest rate. This is available to many different levels of creditworthiness and offered for many different types of debt, depending on your existing relationships with banks or credit unions.
When handled properly, debt consolidation loans can be very powerful tools for improving your financial health. Instead of dealing with many different loans, with different interest rates and different payment dates, you can use one of these loans to make all payments at one time each month, oftentimes with a lower net interest rate. However, this is not a cut-and-dry process, and it still requires you to have your applications approved and then finding the loan with the best terms and conditions.
What Will I Need?
When applying for a debt consolidation loan, you will need much of the same documentation that you needed when you had initially applied for a credit card or other personal loans: income verification, credit report, and proof of financial stability. On top of these generic requirements, since the purpose of this loan is to service your other debts, you will need to elaborate on your current obligations, as well as your assets. These will give the lender a better understanding of what kind of debt you are dealing with, as well as what things, such as houses and cars, they could take as collateral in the event of a bankruptcy.
If necessary, you may also need, or want, a co-signer. This is a person, hopefully with a better credit history and less burdensome current obligations, that can promise the lender that you will make the payments on time because they can help out if you are short on cash.
What Does the Process Look Like?
Checking Your Credit Score
Before the process of applying for a loan officially begins, borrowers should study their credit history to get a feeling for how lenders will look at them. This should be a very objective and rational form of introspection, as you do not want to be let down by the loan terms that are eventually granted to you, and you want to properly budget for your future. Your credit score is arguably the most important factor in determining your interest rate, so it is important that you consider the rates that you are likely to get.
Also, looking over your credit history will allow you to understand exactly what is holding you back. If there are late payments in your past, there is nothing you can do about that now, except continue to be a good borrower. But, if there are a lot of small debts that are driving up your debt-to-income ratio and your credit utilization, you could pay them down one by one, and in the process make yourself look a lot less risky.
Taking Inventory of All of Your Outstanding Debts
If the example above does not apply to you and paying down small debts in chunks is not a viable option, then your next step should be to write down every last detail about your remaining debts. From the amount to the interest rates to the required payment dates, this will help you get a general idea of exactly where you need help, and maybe where you could still be responsible for paying down debts.
A large part of whether or not your application gets approved boils down to how much you end up asking for in credit. Obviously, if you are swimming in high-interest debt, then you should ask for as much as possible, but to increase your chances of getting approved, you should recognize where in your profile you could bite the bullet and continue making payments.
Now, it is your turn to be picky about who you work with. When looking for debt consolidation loans, there is no shortage of potential institutions that you can borrow from. Ideally, you would start with a bank that you already have a relationship with, as your personal connection and established history will make the process easier, and it will likely open you up to rate discounts. But, if that does not work out, you can still look at other banks, credit unions, and online lenders.
Other banks are great for those borrowers with good credit, as this will keep their attention, and it may also give you access to perks and flexibility that is not available at other institutions. Credit unions are similarly great, and they give contracts with lower interest rates to those with lesser credit and more protection in the event of a bankruptcy. However, credit unions are not like banks where anyone could technically apply, as there is some pre-qualifying factor, like being a veteran, teacher, etc. Finally, online lenders are the most convenient, as you never even have to leave your house and can get a decision a lot quicker, but be careful with the fine print - those with bad credit could be subject to exorbitant interest.
In going through the process, you should not arbitrarily narrow down your options. Pre-qualifying and comparing as many loans as possible can be the key to finding the best deal, and most applications and checks do not affect your credit score. Thus, you should take advantage of any opportunity to get a quote on a loan.
Some lenders of debt consolidation loans have the option for direct payment in which they will send the money directly to your creditors. This will make the process very simple for you, as you now only have to focus on the loan. This is something that you should ask about beforehand when shopping around for loans if it is something you would like. You then need to check your debts owed for a zero balance to make sure everything went through correctly. If your lender does not offer direct payment, you will need to do this yourself. You should do it right away to avoid any additional interest that may be accumulating.
Apply for the Loan
Finally, after all of this, comes the time to actually submit loan applications. Once you have a set list of strong potential lenders and you have organized all of the important information, then you can send the applications, typically hearing responses within a week. This process may be boring and time-consuming, but you will be happy that you did it in the long run.
Make your Final Decision and Make Payments
Then, after considering all of the options that you get, you should choose the loan that is right for you. Once you receive the funds, you should act quickly - pay off all of the existing debt that you can to make paying much easier for yourself, and then keep up with these payments until you are home free.
Is this the right thing to do?
While a debt consolidation loan is a great option for many looking to manage their debt, it is not the only way to go about it, and it is not even the most prudent way of doing things, for some people. If your debt is primarily credit card debt, and you think that you can pay it down over the next year and a half, you should look into a balance transfer card. These allow you to pay down all of that balance with absolutely no interest, and if you do not spend any money on that card, you can make a real dent in your debt.
Also, if the debt that you owe is significant, but it is not crushing you right now and you are not in need of immediate cash, then you can continue to work on building credit. Doing so will make it easier for you to actually get the loan when you need it most, and in the process, it can save you a lot of money.
Finally, debt consolidation loans are best for moderate amounts of debt. If you only have a small amount leftover and are having some trouble paying it, it would be best to look for other, short-term options to help out, perhaps even curbing your current spending. Also, if you are paying off a mountain of debt, this will also not be advantageous, as you are likely to only be able to cover a small amount of that debt, and could get yourself into more financial trouble. In this situation, you should seek out help from a credit counselor and create a more comprehensive payback plan, as opposed to relying on a loan.