Debt can feel suffocating. With rising interest rates and economic instability, it's easy to accumulate debt from multiple sources.

Keeping up with payments is overwhelming, leading to late fees and even more debt. If you struggle to manage your debt, a debt consolidation loan may be your solution.

This guide will provide you with all the information you need to know about debt consolidation loans, including:

• What they are and how they work
• How debt consolidation affects your credit score
• How to choose the right loan
• How to apply for one + eligibility requirements
• Pros, cons, and alternatives

Let's go!

By the way — are you looking for a fair, stable loan provider to help consolidate your debt? Lotly might be able to help. We work with you to understand your financial needs, and our network of 50+ lenders nationwide to find you the best possible loan terms. Get in touch today.

What is a debt consolidation loan?

A debt consolidation loan is a personal loan that combines multiple debts, such as credit card balances, medical bills, and other loans, into one manageable monthly payment. This type of loan allows you to pay off all your existing debts and consolidate them into a single loan with a lower interest rate and longer repayment term.

How does a debt consolidation loan work?

When you take out a debt consolidation loan, the lender will use the funds to pay off your existing debts. This means that instead of making multiple payments to different creditors, you only have to make one payment each month to your new lender.

The interest rate for a debt consolidation loan is typically lower than what you were paying on your individual debts, which can help save you money in the long run.

Example:

Say you owe

• $5,000 on a credit card with an interest rate of 20% APR +
• $10,000 on a personal loan with an interest rate of 12% APR

Your monthly interest payments are  $83.50 + $100 = $183.50. If you take out a debt consolidation loan for $15,000 with an interest rate of 8% APR, your monthly payments would now be just $100 — an $83.50 reduction. As well, you now only have one monthly payment instead of two.

Potential savings with debt consolidation (calculators)

• Debt.ca Debt Consolidation Calculator: Compare current debts to consolidation savings.
• Bankrate Debt Consolidation Calculator: Visualize savings with debt consolidation.
• Wells Fargo Debt Consolidation Calculator: Estimate monthly savings from consolidation.

How does debt consolidation affect your credit score?

Debt consolidation can have a positive impact on your credit score. By paying off multiple debts and consolidating them into one loan, you effectively reduce your overall debt-to-income ratio and improve your credit utilization ratio. This can increase your credit score.

However, it is essential to note that applying for a new loan may temporarily lower your credit score. Closing old accounts as part of the debt consolidation process may also have a negative effect.

Overall, if appropriately managed, debt consolidation can positively affect your credit score in the long run.

Tips for choosing the right debt consolidation loan

1. Compare interest rates: The primary purpose of a debt consolidation loan is to save money on interest. It is essential to compare interest rates from different lenders and choose the one with the lowest rate.
2. Check for additional fees: Some lenders may charge origination or prepayment fees, which can add to your overall cost of borrowing. Read the fine print and factor in any additional fees before choosing a lender.
3. Consider repayment terms: While a longer repayment term may result in lower monthly payments, it also means paying more interest over time. Consider your financial situation and choose a repayment term that works best for you.
4. Look for flexible options: Choose a lender that offers flexible repayment options such as the ability to make extra payments or choose your payment date.
5. Research the lender: Before committing to a loan, research the debt consolidation lender's reputation and read reviews from other borrowers. Make sure they are reputable and have good customer service in case you need assistance in the future.

Eligibility requirements for debt consolidation loans

To qualify for a loan to consolidate debt, lenders typically consider your credit score, income, and debt-to-income ratio. A good credit score and steady income can increase your chances of getting approved for a debt consolidation loan with favorable terms and interest rates. Let's dive a little deeper:

• Credit score: Generally, your credit score should be in the range of  580-850 to qualify for a debt consolidation loan. A higher credit score can help you secure a lower interest rate. You can check your credit for free here.
• Income: Lenders want to ensure you have enough income to make the monthly payments on your consolidated loan. This helps them assess your ability to repay the loan.
• Debt-to-income ratio: This is calculated by dividing your total monthly debt payments by your gross monthly income. Lenders typically look for a DTI ratio of 43% or lower, with a lower ratio being more favorable for loan approval.

It's important to note that eligibility requirements may vary among lenders, so it's always best to shop around and compare offers before deciding.

What kinds of debts can you consolidate into this type of loan? Unsecured debt like:

• Credit card debt
• Personal loans
• Medical bills
• Student loans (some lenders may offer specific consolidation loans for student debt)

However, secured debts like mortgages, car loans, or HELOCs are not typically eligible for a debt consolidation loan.

Pros and cons of debt consolidation loans

There are several benefits to getting a debt consolidation loan:

• Lower interest rates: By consolidating your debts into one loan, you can potentially secure a lower interest rate than the individual rates on your current debts.
• Simplified payments: Instead of keeping track of multiple minimum payments each month, you only have to make one payment toward your debt consolidation loan.
• Easier debt management: With one fixed monthly payment, you can budget better and have a clear timeline for when your debts will be paid off.
• Potential credit score improvement: By paying off multiple debts with a consolidation loan, you may see an increase in your credit score as you lower your overall debt utilization ratio.

Of course, there are always a few downsides:

• Longer repayment term: Depending on the debt you consolidate, you may end up with a longer repayment term for your consolidation loan compared to individual loans. This means more interest paid in the long run.
• Additional fees: Some lenders charge origination fees or other upfront costs for a debt consolidation loan.
• Risk of accumulating more debt: Consolidating your debts can free up credit limits on your current accounts, which may tempt you to use them again and potentially accumulate more debt.

Before deciding if a debt consolidation loan is the right choice for you, it's essential to carefully consider both the pros and cons and assess your individual financial situation. 

Debt consolidation loans can be a helpful tool — if you need some advice on whether it's the right tool for you, get in touch with us here at Lotly. We’ll assess your current debt and help you calculate your monthly savings to better help you. 

Ultimately, our goal here is to improve your long-term financial health by replacing high-interest, high-risk debt with more manageable monthly payments. And don’t just take our word for it: on average, we help homeowners save $1,200 a month using debt consolidation.

How to apply for a debt consolidation loan

1. Assess your current debts: Start by making a list of all your outstanding debts, including the balance and interest rate for each.
2. Check your credit score: A higher credit score may lead to better loan options and lower interest rates.
3. Research lenders: Look for reputable lenders that offer debt consolidation loans with favorable terms and rates.
4. Gather necessary documents: Lenders will typically require proof of income, identification, and details about your current debts.
5. Compare offers: Don't settle on the first lender you find - compare offers from different lenders to find the best option for you.
6. Submit an application: Once you've chosen a lender, submit your application and provide any additional documentation they may require.
7. Review and accept the loan terms: After your application is processed, review the loan terms carefully before accepting them.
8. Start making payments: Once you've accepted the loan, make sure to make your payments on time and in full each month to avoid accruing more debt.

Alternatives to debt consolidation loans

Debt consolidation loans offer several benefits, but if they're not the right fit for you, there are other options to consider:

• Debt management plan: This involves working with a credit counseling agency to create a repayment plan for your debts.
• Balance transfer credit card: You can transfer all your high-interest balances onto one low or no-interest credit card, saving you money on interest payments.
• Personal loans from family or friends: Consider asking trusted family members or friends for a loan to consolidate and pay off your debts. Just be sure to have clear terms and repayment plans in place.

Debt can be scary, but options are always available to help manage and pay it off. Do your research, weigh the pros and cons, and choose the best option for your financial situation.

Make your debt manageable with Lotly debt consolidation

Let's recap all we've learned so far:

• Understand the basics of debt consolidation loans. These loans combine multiple debts into manageable monthly payments, often with a lower interest rate and longer repayment terms.
• Evaluate the impact on your credit score when considering a debt consolidation loan. Consolidation can improve your credit by reducing your debt-to-income ratio, but applying for a new loan might temporarily lower your score.
• Explore alternatives if a debt consolidation loan isn’t the right fit. Options like debt management plans and balance transfer credit cards might be viable depending on your situation.

If you're a homeowner looking to use your ownership in your home to reduce your debt payments, Lotly can help. We work with 50+ lenders across Canada to develop the best debt consolidation loan options for you. Get in touch today to see if we're the right fit.

FAQs

Do debt consolidation loans hurt your credit?

Applying for a debt consolidation loan may temporarily lower your credit score due to the hard inquiry on your credit report. However, if you make timely payments and reduce your overall debt, it can positively impact your credit score in the long term.

How hard is it to get a debt consolidation loan?

The difficulty of getting a debt consolidation loan will depend on your credit score, income, and overall financial situation. Lenders may also consider the type of debts you have and their total amount. It's best to research and compare different lenders to find one that offers the best terms for your specific circumstances.

How long does it take to pay off a debt consolidation loan?

This will vary depending on the terms of your loan and how much you can pay each month. Generally, debt consolidation loans have longer repayment terms than individual debts, so it may take several years to repay all your debts fully. However, with lower interest rates and more manageable payments, you may be able to pay off your debt consolidation loan sooner than you would have been able to with individual debts. Plus, since the total monthly payments are lower, it makes paying back your debt much more manageable.

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