Trying to manage a pile of loans with different terms and repayment dates can seem daunting. Loan consolidation is one way to manage your debt, by leveraging lower interest rates and more favorable repayment terms to your benefit.
If you have multiple loans or credit cards with high interest rates, you might feel like you are continually paying interest and not making much headway on the principal of the loan. Loan consolidation can help you destress your payment process and potentially save you thousands over the life of your loan.
It’s not as complicated as it might seem, either. In fact, it’s a way to make just one monthly payment and save on interest simultaneously. Loan consolidation can be a smart financial move, but it is important to know what you’re diving into before you sign that pile of paperwork. This short guide tells you everything you need to know about how loan consolidation works, what types of loans benefit from consolidation, and when to start the consolidation process.
1. What is loan consolidation?
Loan consolidation, at its most basic, is the process of combining multiple debts into one. Usually, this means that you use a new loan or line of credit to pay off your existing debts, thereby “consolidating” your multiple payments into one.
For example, imagine you have the following debt: $5,000 on a private student loan, $10,000 in credit card debt on Card A, and $10,000 in credit card debt on Card B. Your private student loan probably has a high interest rate, and your credit card interest rates certainly aren’t much better. You owe a total of $25,000, and each month you are making three different payments on your various debts. You’re also continuing to rack up interest on each of the debts.
When you took out those loans, maybe you were earning less and living on ramen you bought on credit, but now you have a steady job and a good credit score. Your new financial reality means that you may qualify for a better interest rate and more favorable terms on a new loan.
As such, it’s possible to look into a personal loan, sometimes called a debt consolidation loan, for the full $25,000 you currently owe on your private student loan and credit cards.
Using that loan to pay off your three debts effectively condenses those debts into one single debt of $25,000. This avoids the headache of multiple payments, and ideally, ensures you a lower interest rate and more favorable repayment terms.
2. What type of loan consolidation is best for you?
There are different types of loan consolidation depending on your circumstances and needs. Whether you finally found the perfect job running UI for the next dating app and need a smarter way to pay back your student loans, or you’re a seasoned freelancer who just landed a big project and wants to focus on paying off your credit card debt, there are options for you.
Student loan consolidation: If you have more than one federal student loan, the federal government offers Direct Student Loan Consolidation. This program essentially rolls all of your federal loans into one.
However, because the new interest rate is the weighted average of all your loans combined, it might be slightly higher than your initial interest rate.
You can also consolidate your student loans with a personal loan. If you’re in a healthy financial position with a good credit score and a strong income, a personal loan might give you much more favorable repayment terms, including a lower interest rate and shorter repayment period.
Credit card loan consolidation: If you’ve got a number of credit cards open with varying interest rates that you’re paying back, credit card consolidation might be for you.
Credit card loan consolidation is the process of paying off credit card debt with either a new, low-interest credit card or a personal loan that has better repayment terms and a lower interest rate. Choosing to consolidate with a personal loan can help you improve your credit score and avoid balance transfer fees.
Related: To find out how much interest you are paying on your credit card debt use our Credit Card Interest Calculator.
General loan consolidation: This is for people who have multiple debts from various lenders. If you have some credit card debt, some student debt, and maybe an old personal loan you took out for that study abroad trip, you may be able combine these debts into a single payment. In this case, you’d consolidate with a personal loan and would no longer have to deal too many lenders.
3. Why should you consider loan consolidation?
There are as many reasons to consider loan consolidation as there are overpriced frozen coffee drinks, but here are some of the most compelling reasons:
You want to be a minimalist. Forget Marie Kondo-ing your apartment by throwing away everything you own except a single Eames chair and decorative light bulb. Instead, Marie Kondo your debt by minimizing excess fees, bloated interest rates, and decades-long repayment plans.
Your financial circumstances have improved. Maybe you spent the last three years living off student loans to finish your law degree, and now you’ve started at your dream firm. You have a steady salary, and you’ve taken control of your credit score.
Because of your financial growth, you may be able to qualify for lower interest rates than when you first took out your loans. Loan consolidation can reward all that hard work by saving you money on interest payments.
You’ve got sky-high credit card rates. If thinking about the interest rate on your current credit cards makes you want to hide under your desk, consolidating those cards with a personal loan may be just what you need. High interest rates can lead to thousands of dollars in fees over the time it takes to pay off your credit card. Using a personal loan to consolidate those cards can reduce your interest rate and help you stop feeling nauseous every time you make a credit card payment.
4. When should you consider loan consolidation?
Now! But seriously, if you’re in a position where you have multiple outstanding debts, you might be in a position where loan consolidation could save you money and simplify your life.
If you’re ready to simplify your payments and see how much you could save with consolidation, check out loan consolidation with SoFi.