How to use a personal loan for debt consolidation

June 20, 2019 - 5 min read

Debt consolidation can lighten your load

If you’re finding your debt burden uncomfortable, you’re not alone.

According to the Federal Reserve, Americans owed more than $1 trillion in store and credit card debt in April 2019.

And another $3 trillion on other loans, such as ones for autos, mobile homes, education, boats, trailers and vacations. Worse, those numbers don’t include mortgages. So it’s not surprising many are looking to debt consolidation to lighten the load.

Enter personal loans.

This emerging financial tool is helping more consumers by the day. If used correctly, personal loans can help tame debt and make it more realistic to become debt-free.

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Are you paying credit card interest rates? Then you’re a candidate for debt consolidation

The problem of debt is particularly acute because much of this general borrowing is far from cheap.

One company that monitors these things reckons you should have expected to pay on average 19.24 percent APR on a new card you signed up for in June 2019.

If you pile borrowing on that, and make only minimum payments, you’ll pay a small fortune in interest.

How a personal loan can help with debt consolidation

Debt consolidation can provide a more affordable way forward. Personal loans typically come with significantly lower rates. They also provide a clear path to reducing your debt burden.

That’s because these loans are highly predictable. You borrow a fixed amount and pay it back in equal monthly installments over a fixed period. That period is largely of your choosing and you’ll probably select a term that lets you comfortably afford the repayments.

But you have to set that period before you borrow. So, unlike with a credit card, you can’t be tempted to pay less when you want, or drive the balance back up.

Other advantages of personal loans include:

  1. You get the money to pay off your other debts quickly, often within 24 hours, though it may take a week
  2. Setting up a loan is usually cheap and often free
  3. The money’s yours to do what you like with. So you can pay off all sorts of debt with a single personal loan
  4. Interest rates are typically lower than with most other debts. So you can pay down more of your debt faster
  5. You have to worry about making only one payment a month — so no more juggling bills

Another plus is that you’re much less likely to harm your credit score. If you have 10 credit cards, you have 10 times the chances to miss a payment. But that’s not where the risk ends when it comes to your credit.

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High card balances harm your credit score

Credit scoring technologies, such as FICO’s, place a lot of emphasis on something called “credit utilization.”

This applies only to “revolving credit” (mostly store and credit cards). This formula compares your current balance to your total available credit limit.

(Credit utilization formulas do not apply to installment loans, including personal loans.)

For instance, imagine the following scenarios.

Good credit utilization

  • 3 credit cards at $5,000 limit each ($15,000 total limit)
  • $2,000 balance spread across all cards
  • Credit utilization: 13%

Bad credit utilization

  • 2 credit cards at $3,000 limit each ($6,000) total limit)
  • $4,000 balance across both cards
  • Credit utilization: 67%

If your card balance is greater than 30 percent of your credit limit, you’ll be actively harming your credit score.

This applies to every individual card and to all your balances/limits combined.

And that 30 percent really is a magic number. Go below that and you’ll help your score only a tiny bit. Go above it and you could soon cause real damage.

Obviously, the closer you get to maxing out your plastic, the worse things will get.

Credit utilization accounts for 30 percent of your credit score

Credit utilization accounts for a whopping 30 percent of your total credit score, according to FICO. Even if you can’t or don’t want to pay down all your balances using a personal loan, getting them all below 30 percent of your credit limits would be a smart move.

Related: 820 credit score: How much cheaper are loans with great credit?

Make a plan if you will use a personal loan

The benefits of debt consolidation are obvious and real. So why do so many financial gurus warn against it?

Perhaps the main reason is that consolidating means borrowing yet more. That’s fine if you’re highly self-disciplined. But it can be a problem for those who aren’t.

They can find themselves in even more trouble a year after consolidating. They’ve run up their card balances again while they’re still paying down the personal loan they used for consolidation. They owe more than they did in the first place.

How to avoid making things worse

The only way to avoid this is to stop borrowing. It can harm your credit score to close existing accounts. But take your credit cards out of your wallet and carry around only your debit card. If you are worried about getting tempted, you could cut them up and order replacements only when your debt consolidation loan is paid off. Or you could lock them away at home or at a family member’s place.

But if you’re serious about getting your spending under control you should also set up a household budget — and stick to it. Spending more than you make never works out in the end.

Related: How to set and stick to a budget

To repeat, you’re not alone if you’ve let your spending run away from you. USA Today reported in March 2019 that the average American owes $6,354 on bank-issued credit cards. But nearly half are able to “zero out” their balances each month. And, presumably, that means those who don’t “zero out” must on average owe roughly double that — and often way more.

So don’t get mad that your finances are a mess — start cleaning them up, potentially with a personal loan.

Personal loans for non-credit-card debt consolidation

Of course, credit cards aren’t the only thing you can pay off with a personal loan.

Other types of high-interest debt are candidates, too. For instance, maybe you have medical bills or collections you’d like to say “good-bye” to once and for all. Or your auto loan rate is too high, but you can’t refinance it. You could wrap these and other types of debt into one loan to ease the financial and mental burden.

See the most common uses for personal loans in our article Top 12 reasons to use a personal loan.

Get a personal loan eligibility assessment

Personal loans are easier to get than mortgages. But there are still qualification standards.

Start your application for a personal loan online now and see what you qualify for quickly and easily.

*TheMortgageReports and/or our partners are currently unable to service the following states - MA, NV

Peter Warden
Authored By: Peter Warden
The Mortgage Reports Editor
Peter Warden has been writing for a decade about mortgages, personal finance, credit cards, and insurance. His work has appeared across a wide range of media. He lives in a small town with his partner of 25 years.