Debt Consolidation vs Personal Loan

Key factors to consider before making a decision

Before choosing between debt consolidation and taking out a personal loan for another purpose, you should carefully evaluate several important factors.

• Credit score: Your credit score plays a crucial role in determining what options are available to you and how much they’ll cost. Generally, you’ll need a credit score of at least 580-600 to qualify for most personal loans, though the best rates are typically reserved for borrowers with scores above 720. If your credit score is on the lower end, you might face higher interest rates that make consolidation less beneficial, or you might not qualify at all.

• Interest rates: Interest rates are perhaps the most critical consideration for debt consolidation. Calculate the weighted average interest rate of your current debts and compare it to the rate you’d receive on a consolidation loan. Include any balance transfer fees or loan origination fees in your calculations, as these can affect the true cost. If the consolidation loan rate isn’t meaningfully lower than your current average rate, consolidation may not save you money.

• Loan term: Consider the loan term carefully. While extending your repayment period through consolidation can lower your monthly payment, it often means you’ll pay more in total interest over time. For example, if you currently owe $10,000 across various credit cards and pay it off in three years, that’s different from consolidating into a seven-year personal loan. Even with a lower interest rate, the longer term might result in higher total interest paid.

• Cash flow: Your monthly cash flow is another important factor. Debt consolidation should ideally reduce your monthly payment burden, freeing up cash for other expenses or savings. Calculate what your new monthly payment would be and ensure it fits comfortably within your budget. Remember that you should also avoid taking on new debt after consolidating, or you’ll end up with both the consolidation loan payment and new debt payments.

• Fees: Finally, consider any fees associated with either option. Personal loans often come with origination fees ranging from 1% to 8% of the loan amount. Balance transfer credit cards typically charge 3% to 5% of the transferred balance. Home equity loans and lines of credit have closing costs similar to mortgages. These fees can add up quickly and should be factored into your decision.

Potential pitfalls and how to avoid them

Both debt consolidation and personal loans come with potential traps that can worsen your financial situation if you’re not careful.

• New debt: One of the biggest risks with debt consolidation is the temptation to accumulate new debt. After you consolidate your credit cards, those cards will have zero balances. Many people see these available credit lines as an invitation to spend, racking up new charges while still paying off the consolidation loan. This behavior can leave you in a worse position than before consolidation. To avoid this, consider closing some of the credit card accounts after consolidation, or at least removing the cards from your wallet and online shopping accounts.

• Total cost: Another common mistake is focusing solely on the monthly payment rather than the total cost. A lower monthly payment might feel like relief, but if it comes with a much longer loan term, you could end up paying significantly more in interest over the life of the loan. Always calculate the total amount you’ll pay, including all interest and fees, before committing to any loan.

• Risk: Some people choose debt consolidation methods that convert unsecured debt to secured debt, such as using a home equity loan to pay off credit cards. While this might offer lower interest rates, it puts your home at risk. If you can’t make payments on an unsecured personal loan, your credit will suffer and you might face collections, but you won’t lose your home. With a home equity loan, default could lead to foreclosure.

• Habits: It’s also crucial to address the underlying financial habits that led to debt accumulation. Consolidation or taking out a personal loan treats the symptom but not the cause. Without a realistic budget, better spending habits, and potentially increased income or reduced expenses, you’re likely to find yourself in debt again. Consider working with a financial counselor or using budgeting tools to develop better financial practices.

Alternative strategies worth considering

Before committing to debt consolidation or a personal loan, consider whether other strategies might work better for your situation.

• The debt avalanche method involves listing all your debts by interest rate and aggressively paying off the highest-rate debt first while making minimum payments on others. Once the highest-rate debt is eliminated, you move to the next highest, and so on. This method saves the most money on interest but requires discipline and patience.

• The debt snowball method takes the opposite approach, focusing on paying off the smallest balance first regardless of interest rate. This provides psychological wins that can keep you motivated, though it typically costs more in interest than the avalanche method.

• Negotiating directly with your creditors might help, especially if your debt is primarily on credit cards. Many credit card companies will lower your interest rate if you call and ask, especially if you have a history of on-time payments or can mention competitive offers you’ve received. Some may even offer hardship programs with reduced rates and payments if you’re experiencing financial difficulties.

• Credit counseling agencies offer debt management plans where they negotiate with your creditors on your behalf to reduce interest rates and create a structured repayment plan. You make a single payment to the agency, which distributes funds to your creditors. This option can be effective but will likely appear on your credit report and may require you to close your credit card accounts.

• In severe cases, bankruptcy might be the most appropriate option, though it should be a last resort due to its long-lasting impact on your credit and financial life. Consulting with a bankruptcy attorney can help you understand whether this option makes sense for your situation.

Making your decision

Choosing between debt consolidation, a personal loan for another purpose, or an alternative strategy requires honest assessment of your financial situation, discipline, and goals.

• Start by gathering all your financial information: every debt you owe, the interest rate on each, the minimum payment, and the total balance. Calculate your current monthly debt payments and the total interest you’ll pay if you continue on your current trajectory. Then research what interest rates you might qualify for on a consolidation loan or personal loan based on your credit score.

• Run the numbers on multiple scenarios: What would your monthly payment and total interest be with a three-year consolidation loan? A five-year loan? What if you used the debt avalanche method instead? Which option frees up the most monthly cash flow? Which costs the least over time?

• Consider your personal tendencies and behaviors honestly: Are you disciplined enough to avoid running up new debt after consolidation? Can you stick with a debt repayment strategy without the forcing function of a single loan payment? Do you need the psychological simplification that consolidation provides, or would you prefer the flexibility of managing debts separately?

The bottom line

Debt consolidation and personal loans are valuable financial tools, but they’re not magic solutions that erase debt without effort. A personal loan provides flexible funding that you can use for various purposes, including debt consolidation if that’s your goal. Debt consolidation is a strategy that can simplify your finances and potentially save money on interest, with personal loans being one of several methods to achieve it.

The right choice depends on your specific circumstances: your credit score, interest rates available to you, the total amount of debt you’re managing, your monthly cash flow, and most importantly, your commitment to changing the financial behaviors that led to debt in the first place. By carefully evaluating your options, running the numbers, and honestly assessing your situation, you can make an informed decision that sets you on a path toward financial stability and eventually, freedom from debt.

There’s always JG Wentworth…

Do you have $10,000 or more in unsecured debt? If so, there’s a good chance you’ll qualify for the JG Wentworth Debt Relief Program.* Some of our program perks include: 

• One monthly program payment 

• We negotiate on your behalf 

• Average debt resolution in as little as 24-60 months 

• We only get paid when we settle your debt  

• Some clients save up to 45% before program fees