A debt consolidation loan allows you to combine several debts into a convenient, single monthly payment. You may also be able to use a lower-interest loan to pay off other loans that carry high-interest rates. Unfortunately, the people who most need a debt consolidation loan may have credit issues that make it difficult to get good terms on a new loan or even to get approved for a loan at all.
There are ways to get a debt consolidation loan even with less than optimal credit, and there are alternatives to debt consolidation loans for people with a less than perfect credit history. Some of these methods involve risks and potential drawbacks that you will need to consider.
Remember that a debt consolidation loan will only help if you resolve the issues that got you into debt in the first place.
What Is a Debt Consolidation Loan?
A debt consolidation loan is a personal loan that you take out in order to pay off several other debts. This means that several smaller debts are collected into a single loan payment.
Combining your debts into a single monthly payment is convenient and helps you keep track of your payments. That may help you avoid late or missed payments, which can harm your credit. If you can get a debt consolidation loan at a lower interest rate than the loans you are paying off, you can save money on interest. You may also be able to lower your monthly payment.
Many borrowers use debt consolidation loans to pay off credit card debt. Credit card debt often carries high-interest rates, so it’s often possible to get a better rate on a debt consolidation loan.
The features you look for in a debt consolidation loan will depend on your goals. If your goal is to reduce your interest cost, look for a loan with a lower interest rate than the debts you want to pay off. If you want to lower your monthly payment, look for a loan that has a longer payment term than your existing loans. Note that a longer payment term may increase your total interest payment even with a lower interest rate.
How to Get a Debt Consolidation Loan With Bad Credit
There are a few things to do or consider when trying to secure a consolidation loan with bad credit:
- Start by checking your credit score and credit report. You will need to know your score so you can compare it to your lender’s requirements. Review your credit report carefully. There may be errors that are affecting your score and your eligibility for loans.
- Consider adding a cosigner. A cosigner with good credit can improve the terms you’re offered and your chances of approval. Be sure you and your cosigner understand the obligations and risks of cosigning a loan.
- Consider waiting. If your credit is near a cutoff point and you don’t urgently need to consolidate your debts, you may get a better deal if you wait and focus on making on-time payments and managing your money well. A small improvement in your credit can make a significant difference in the terms you are offered on a new loan.
- Shop around. Look for lenders that are flexible and willing to work with borrowers who have imperfect credit. Look for the best interest rates and for features like direct payment to lenders.
- Consider a secured loan. Using your home equity or retirement funds to consolidate debt can get you easier approval and lower interest, but you’ll have to consider the risks to your assets.
Things to Know About Consolidation Loans
A debt consolidation loan re-organizes debt, but it does not reduce it. You will still need to make the payments on your new loan on time. You will need to avoid excessive spending or taking on new debt to take full advantage of debt consolidation.
Most debt consolidation loans are credit-based. If you have credit problems it may be difficult to get a debt consolidation loan or to get a better interest rate than you are paying on your existing loans. It may still be possible to get a debt consolidation loan with bad credit, but you will have to decide whether the terms of the loan are good enough to achieve your objectives.
Some loans are specifically designed for consolidating other debt. That means that some debt consolidation lenders will pay the loans you wish to consolidate directly, which removes the temptation to use the money for other purposes.
Where To Get a Debt Consolidation Loan
Your local bank or credit union is a good source for a debt consolidation loan, even if your credit is flawed. If you have an existing business relationship with a financial institution, they will know your finances. You may be able to discuss loan terms directly with decision-makers and you may be able to persuade them to lend to you based on factors other than your credit.
If you are a credit union member you may be able to get good terms on a loan from your credit union. Many credit unions have alternate credit requirements for members and are willing to base loan decisions on alternative financial data, not just your credit history.
Banks and credit unions may check your credit report. This will leave a hard inquiry on your credit record, which can affect your credit. If you keep your loan comparisons within a 2-week period credit reporting companies will recognize that you are shopping for a loan and will register only a single hard inquiry on your credit report.
Many online lenders offer debt consolidation loans, and some specialize in working with borrowers who have credit issues. Online lenders often allow pre-qualification with only a soft inquiry on your credit report, which does not affect your credit.
Online lenders allow easy rate comparison and application and often make approval decisions faster than a bank or credit union could. They may be more likely to approve a loan with bad credit. You may have to pay a high-interest rate and some online lenders will charge an origination fee, so you’ll have to pay close attention to the loan’s terms.
Some Other Options for Consolidation Loans with Bad Credit
If you struggle securing a consolidation loan, consider other loans that can be used in a similar fashion:
- If you have equity in your home you may be able to use a home equity loan or a home equity line of credit to consolidate debt. Because these loans are secured by your property, they carry low-interest rates and approval is often relatively easy. There are risks, though: if you fail to pay the loan you could lose your home.
- If you have a 401(k) retirement fund you may be able to borrow from that fund and use the proceeds to consolidate debt. These loans offer low-interest and easy approval, but you will not earn interest on the borrowed amount until it’s paid back and you may face tax penalties if you fail to pay the loan.
- Serving and former members of the military may be eligible for loan programs specifically designed for current and former members of the military. Some of these may be willing to work with borrowers who have low credit scores and to base evaluations on factors other than a credit score.
Be alert for predatory lenders, who often target individuals with credit problems. Be sure that the interest rate you are quoted is an annual percentage rate and that it is lower than the rate you are paying already. Avoid any lender that asks you to pay a processing fee upfront and remember that it’s illegal to make a loan offer over the phone.
Alternatives To A Debt Consolidation Loan
If your credit is in really bad shape you may not be able to get a debt consolidation loan at terms that will help you. Don’t give up. There are other ways to manage your debt:
- Debt management plans are offered by credit counseling agencies. You will make a single monthly payment to the counseling agency, which will pay your creditors. You may have to close some accounts and you may not be able to take on new debt for the duration of the plan.
- Hardship programs may be available for borrowers whose credit card debt problems have been complicated by medical bills, job loss, natural disasters or other factors they can’t control. Issuers may delay penalties, reduce rates, or give grace periods to approved borrowers. Many card issuers have these programs, but they generally aren’t advertised. You’ll have to ask your card issuer.
- Debt settlement can be negotiated directly with creditors or through a debt settlement company, which will charge you a percentage of the debt they settle. Debt settlement can have a serious impact on your credit and is usually used as a last resort by people in serious debt trouble.
- Bankruptcy is an option if you are completely unable to pay your debts. Bankruptcy will wipe out most unsecured debts and give you a fresh start. Your credit will suffer but you can begin rebuilding it with a clean slate.
Managing Your Debt Consolidation Loan
A debt consolidation loan is a step toward solving your debt program, but it doesn’t make your debts go away and it won’t solve your problems by itself. These steps can help you use your debt consolidation loan effectively:
- You will have to make the payments on your debt consolidation loan on time to avoid further damage to your credit.
- Making a realistic budget, sticking to that budget, and tracking your spending carefully can help you make your payments and manage your debt.
- Avoid taking on new debt or spending on your credit cards until your debt consolidation loan is paid. Consolidation won’t help if you keep racking up new debt.
- Keep in touch with your lender. If you are going to make a payment late or if you’re having problems paying, contact the lender and let them know. Many lenders are willing to work with borrowers who make an effort to resolve issues.
- Keep monitoring your credit and your credit report. Staying familiar with your finances can help you.
A debt consolidation loan is a valuable tool that can help some borrowers manage debt. You will need to examine your credit, your finances, and your loan options to decide whether it’s the right tool for you.