How to Get a Debt Consolidation Loan

Steps to getting a debt consolidation loan

If you have multiple loans or credit cards, it can become increasingly difficult to keep track of due dates, minimum payment amounts and varying interest rates, fees and penalties. Consolidating these debts into one account simplifies repayment, which can make it easier to pay them off faster.

A debt consolidation loan should be large enough to combine most, if not all, of your smaller obligations into one convenient location to save both money and time. Consider the following example.

Calculating how much to borrow

Robert has three credit cards, a personal loan and a small amount of medical debt. Here’s what he owes, listed from the highest to lowest interest rate:

• Credit card #3: $1,300 at 23% interest
• Medical debt: $2,300 at 15% interest
• Credit card #1: $3,500 at 13% interest
• Credit card #2: $5,000 at 8% interest
• Personal loan: $9,700 at 5% interest

Robert owes a total of $21,800 across these debts, excluding his mortgage and car payment. To consolidate all of them, he’d need a loan for at least $21,800, plus enough to cover any fees.

Debt consolidation companies may charge origination fees of 1% to 8% of the loan amount, so Robert should factor those costs into how much he needs to borrow.

How to get a debt consolidation loan

Take these steps to get a debt consolidation loan.

1. Figure out how much you need

“First, total your outstanding debts, interest rates and monthly payments, then determine what can realistically be consolidated into one lower-cost payment,” said Nick Panize, president and CEO of Westgate Capital Ventures in Los Angeles, California.

It can help to list your debts from the largest amount owed (or the highest interest rate) to the least to determine your payoff priority — especially if your consolidation loan doesn’t cover all of your debt.

2. Check your credit score

If you have a lot of debts, but have been making payments on time and your credit score is in good shape, you’ll have an easier time securing a consolidation loan with good terms. If you have a poor credit score, be wary of consolidation loan offers with poor terms. Exorbitant interest rates and prepayment penalties can sink you further into debt.

Know your credit score before applying for debt-consolidation loans so that you can better understand which loans you’re likely to qualify for and avoid offers that could make your debt worse.

3. Shop local and online lenders

If your credit is in good shape, it’s time to shop around for the best consolidation loan you can find. If you’re a member of a credit union, check with the credit union first. These are some of the best resources for getting a debt consolidation loan. Also check with local banks or online providers with a good reputation.

4. Compare loan terms

Don’t automatically opt for a lender that offers to loan the most money. This can be tempting, especially when you’re trying to cover a large amount of debt. But the interest and penalties may not be favorable, and your monthly payments could be hard to make.

A longer repayment period can also be enticing since it lowers your monthly amount due. However, unless you need this option to manage short-term budget constraints, you could end up paying much more money over the life of the loan than you would have paid toward each account.

5. Apply and submit documents

Once you’ve found a loan with terms that work for you, submit your application. The lender may ask for documentation such as proof of income, employment information, identification and details about your current debts. Having these documents ready can speed up the application process.

Avoid applying for multiple loans at once unless you know whether the lenders use hard or soft credit checks. Multiple hard inquiries in a short period can affect your credit score.

6. Pay creditors

After your loan is approved and funded, use the money to pay off the balances you’re consolidating. Some lenders will pay creditors directly, while others deposit the loan funds into your account for you to use.

Keep making regular payments to your accounts until you know the creditors have been paid off and your accounts are closed.

7. Set autopay and avoid new debt

Set up automatic payments for your consolidation loan so you don't miss one. Then, focus on paying down the loan without adding new balances to old accounts.

If you continue using credit cards after consolidating their balances, you could end up with both the new loan payment and additional credit card debt. A consolidation loan can simplify your payments, but changing your spending habits is key to staying out of debt.

» MORE: Best debt consolidation loan companies

Debt consolidation loan requirements

Like with any loan, there are certain requirements you’ll need to meet before getting approved for a debt consolidation loan. The higher the loan amount, the stricter the requirements.

Lenders will pull your credit report and credit score when considering your loan request and will likely want to see proof of income and the type of income (e.g., W2, 1099, etc.). Lenders will examine your debt-to-income (DTI) ratio, which compares your income to the amount of debt you’re carrying.

These are going to be some of the biggest factors in approval and pricing in general, said Panize. “There’s no universal minimum score, but generally the stronger your credit and lower your DTI, the better your interest rates and options,” he said. Lenders also typically ask for bank statements, photo identification and information on the debts being paid off.

If you have bad credit, it will be harder for you to obtain a consolidation loan, particularly if you need a lot of money to cover several debts. A local credit union might be willing to absorb the risk, especially if you have an established relationship with it. Online lenders like Upgrade lend to a wide range of credit scores.

» RELATED: Does debt consolidation hurt your credit?

Debt consolidation loan options compared

Debt consolidation can take several forms, and each option comes with different costs, risks and repayment terms.

Debt management plans consolidate payments to lower rates and waive fees while you pay off the full balance.

Common choices include balance transfer credit cards, unsecured personal loans, home equity loans, home equity lines of credit (HELOCs) and debt management plans. The right choice depends on the type and amount of debt you have, your credit profile and whether you own a home.

Here, we take a look at personal loans and home equity loans or HELOCs.

Personal loan

An unsecured personal loan usually makes sense when the loan amount is manageable and the pricing is reasonable, said Panize. This option allows you to make all or most of your debt payments to one creditor, with a single interest rate and monthly payment. If the loan covers all your debt, paying down your balances each month will be simple.

Balance transfer cards move balances from multiple accounts to a new card with a low interest rate.

If the loan doesn’t cover all of your debts, Panize advises, “you apply the proceeds toward the highest-interest debt first. Whether the lender pays creditors directly or deposits the money into your account is mostly a matter of control and discipline. Direct payoff removes the temptation to use the proceeds elsewhere, while receiving the funds yourself gives you more flexibility.”

Home equity loan or HELOC

Home equity loans and HELOCs can offer lower interest rates than some other consolidation options, but both use your home as collateral. That means you're putting your home at risk to pay off consumer debt, said Panize. If you take on additional debt and can't keep up with your payments, you could ultimately lose your home.

A home equity loan gives you a lump sum that you repay over a set period, typically with a fixed interest rate and predictable monthly payments. A HELOC, on the other hand, works more like a credit card: You can borrow, repay and borrow again up to your credit limit. HELOCs typically have variable interest rates, so your payments can change over time.

Both options are available only to homeowners with sufficient equity in their homes.

» RELATED: Balance transfer or personal loan?

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