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Wondering about the difference between a debt consolidation loan vs. personal loan? It’s actually a bit of a trick question. Debt consolidation loans are, usually, simply personal loans that are used to pay off multiple existing debts. It may be marketed specifically toward debt consolidation, but it’s essentially the same type of unsecured installment loan as a personal loan.
Key Points
• Debt consolidation loans are personal loans specifically used to pay off existing debts.
• A personal loan is an unsecured installment loan that can be used for almost any expense and is paid back over a set term with fixed interest.
• Personal loans used for debt consolidations usually do not require collateral.
• Key benefits include the predictability of a fixed interest rate and the ease of making one monthly payment instead of many.
• Drawbacks include strict eligibility requirements (like higher credit scores).
What Is a Debt Consolidation Loan?
A debt consolidation loan is an unsecured loan — that is, one on which you don’t put down collateral, like a house or a car — that is then used to pay off multiple existing debts. They can sometimes be called credit card consolidation loans, too.
Debt consolidation loans can be a fast and useful tool toward debt repayment, provided you are confident in your ability to pay each installment on time and avoid taking on other debts in the process.
How Debt Consolidation Loans Work
Here’s an example of how debt consolidation works.
Say you have a total of $40,000 in debt: $10,000 in credit card debt across multiple cards, $15,000 in medical debt, and $15,000 in student loans.
Keeping track of all those payments each month can be challenging, potentially leading to late or missed payments, which can hurt your credit score. Additionally, some of those types of debt, such as credit cards, are likely to have high interest rates that can weigh down your progress toward your financial goals.
If you take out a $40,000 debt consolidation loan, you can use the funds to pay off credit card debt. While you’ll still have the same amount of total debt, it’ll all be contained under one single monthly payment — and depending on the loan you qualify for and your existing interest rates, you may save money on interest, too. Of course, it will be important not to run up new credit card charges while you are paying down the debt consolidation loan.
What Is a Personal Loan?
A personal loan is an installment loan, one paid back over time in equal monthly payments, that you can use toward almost anything. (Of course, when you take out a personal loan, there will be fine print regarding what you can and can’t use the funds for; for instance, you’re usually expressly forbidden to use the money for college tuition, to make a downpayment on a home, for gambline, or for anything illegal.)
As is true of all unsecured loans, sometimes also known as “signature loans,” personal loans (and debt consolidation loans) can have more stringent qualification requirements, from income verification to credit score to debt-to-income (DTI) ratios. That’s because the bank doesn’t have a physical asset, like a home or car, as collateral, to collect if the borrower stops paying the loan, making these loans a riskier prospect from the lender’s end.
How Personal Loans Work
Personal loans are quite simple: You borrow money from a bank or financial institution, use it for whatever cost you’re hoping to have covered (often medical expenses, home improvements, or debt consolidation), and pay it back over time. Of course, you’ll also pay interest, which is the cost of the loan and the way the lending institution makes money.
Personal loans vary widely, but generally have repayment terms ranging from two to seven years (which may be expressed as 24 to 84 months). Most personal loans offer a fixed interest rate, which means your monthly installment won’t change over time. Personal loans can be used for many purposes, everything from emergency loans to wedding loans.
Debt Consolidation Loan vs. Personal Loan: Key Differences
As mentioned above, the only real difference between debt consolidation vs. personal loans is what they’re used for. In other words, debt consolidation loans are personal loans. They’re just personal loans that are used toward debt consolidation.
Pros and Cons of Each Option
Like any financial product, debt consolidation loans, and personal loans in general, do have both drawbacks and benefits to consider. Here are a few of the biggest ones at a glance:
Benefits of Personal Loans (Including Debt Consolidation Loans)
• Flexibility. Personal loans can be used for most purpose, including ones that can be smart financial choices like debt consolidation.
• Accessibility. You don’t need any collateral to get a personal loan.
• Ease. Especially if you’re using a personal loan to consolidate debt, having one monthly payment rather than many can make your life significantly easier — and may even save you money on interest.
• Predictability. Most personal loans have fixed interest rates and a pre-set repayment term, making them a predictable monthly expense.
Drawbacks of Personal Loans (Including Debt Consolidation Loans)
• It’s still debt. No matter what you take out your personal loan for, you’ll need to repay it, and if you can’t or won’t, it can hurt your credit score.
• Strict eligibility requirements. Because personal loans tend to be riskier for the lending institution, they often require higher credit scores and other qualification requirements.
• They can be costlier than other types of loans. Again, because they’re riskier and the lending institution doesn’t have collateral to fall back on, personal loans can sometimes have higher interest rates and peripheral costs than other types of debt — but it can still work out in your favor in many debt consolidation scenarios.
Which One Is Right for You?
Debt consolidation loans are simply a subset of personal loans.
If you have significant amounts of debt that you’re ready to pay off, feel confident that you can make the payments on a loan, and have a strong enough credit history to qualify, a debt consolidation loan can be a helpful way to get a leg up on your debt repayment journey. Does debt consolidation hurt your credit score? As long as you make your monthly payments on time throughout the term of the loan, the long-term benefit to your credit score will likely outweigh any short-term drop in score that would result from consolidating debt, which can alter your credit mix.
If you have another major expense, like medical bills or home repairs, a personal loan may be an option to consider — but remember, like all debt, it comes with risks.
Alternatives to Consider
As you explore personal loan vs. debt consolidation benefits and drawbacks, you might be wondering if there is another possible solution to your debt challenge. Trying to pay down debt, but not sure a debt consolidation loan is the right move for you? Some alternatives to consider include:
• A balance transfer credit card
• The Snowball Method or Avalanche Method of paying down debt. “The avalanche method of debt payoff is where you focus extra money on your more expensive, high-interest debt first. Just pay the minimum on your other debts. You’ll eliminate debt one loan or credit card at a time,” explains Brian Walsh, CFP® and Head of Advice & Planning at SoFi.
• A cash-out mortgage refinance
• Filing for bankruptcy
Each of these moves have their own pros and cons, of course, so it’s a good idea to talk to a financial professional and do research before you make any decisions.
The Takeaway
Debt consolidation loans are personal loans that are used to consolidate debt. So there isn’t really a debt consolidation vs. personal loan choice to make. A new personal loan would cover the total cost of all the existing debts, allowing borrowers to make one easy monthly payment.
Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. See your rate in minutes.
FAQ
Is a debt consolidation loan the same as a personal loan?
A debt consolidation loan is simply a personal loan that is used to consolidate debt. Some lenders market them as separate products, but they work in the same way as any personal loan: The borrower makes monthly payments over time.
Can you use a personal loan to consolidate debt?
Personal loans can be used to pay off multiple debts, consolidating them into one, easier-to-manage monthly payment. This strategy is known as debt consolidation, and some lenders market their personal loans specifically as debt consolidation loans.
Will a debt consolidation loan hurt my credit score?
While applying for the loan and acquiring “more” debt may temporarily ding your score, if you immediately use the funds to pay off existing debts and remain diligent about paying the new loan each month, debt consolidation loans have the potential to help you change your score. However, if you take out other loans while you’re repaying, or fail to make your payments on time, it may hurt your score.
What credit score do I need to qualify for a debt consolidation loan?
Each lender has its own requirements for debt consolidation loans. However, because these are unsecured loans, they’re riskier for banks, which means the credit score requirements may be higher than for other types of secured loans like auto loans or mortgages.
How do I choose between a debt consolidation loan and a balance transfer credit card?
A balance transfer credit card works well if you’re sure you can pay off the entire balance in the promotional 0% period before the full credit card interest rate kicks in. However, this period is usually short, often only a single year. If you’ll need more time to pay off the debt, and have many different kinds of debts rather than just credit card debt, a debt consolidation loan may be a better option.
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