How does a debt consolidation loan work?

Keeping up with debt can feel easier when you have fewer payments to manage. A debt consolidation loan combines multiple debts into one monthly payment with a clear payoff timeline.

If you’re considering consolidation, understanding how a debt consolidation loan works can help you decide whether it’s the right fit. Here’s what you need to know before you apply.

What is a debt consolidation loan?

A debt consolidation loan is often an unsecured personal loan used to pay off existing debts, such as high-interest credit card balances, medical bills or loans. Instead of managing several balances, you’ll repay one new loan.

Unlike revolving credit options, like a credit card, a debt consolidation loan typically has a fixed interest rate, a predictable monthly payment and a set payoff date. You’ll know from the start when the loan is scheduled to be paid off.

However, debt consolidation doesn’t reduce the amount you owe. It reorganizes your debt into a new loan.

How does a debt consolidation loan work?

A debt consolidation loan works in 3 basic steps: You borrow the funds, use them to pay off debts and then repay the new loan through one monthly payment.

You borrow a lump sum

You borrow a lump sum to cover all the debts you want to consolidate. Depending on the lender, funds may go directly to your creditors, or they may be deposited into your account so you can pay off your debts yourself.

Your debts get paid off

The funds from your debt consolidation loan are used to pay off the eligible debts included in the consolidation. Depending on the lender and loan terms, the loan proceeds may be sent directly to your creditors, or you may be responsible for using the funds to pay off those debts. Once the payments are processed, those balances may be reduced or paid off, and you’ll be responsible for repaying the new consolidation loan.

You repay the new loan with one fixed payment

To pay your debt consolidation loan, you’ll make a single fixed monthly payment to your new lender. Because the interest rate and term are set from the start, that payment amount stays the same until the loan is paid off, giving you a clear timeline to work toward.

How does debt consolidation affect your credit score?

Debt consolidation doesn’t automatically impact your credit score. Applying for a loan may cause a small drop at first, but paying your bills on time and lowering credit card balances can help your credit over time.

In the short term: Applying for a loan typically results in a hard inquiry, which may cause a small drop in your credit score. Opening a new account can also lower the average age of your credit accounts.

In the long term: If the loan funds are used to pay down credit card balances, your credit utilization ratio may decrease. Making on-time payments on the new loan can also help support your payment history. However, consolidating your debt doesn’t reduce the total amount you owe.

The long-term effect often depends on what happens after you consolidate. Keeping new debt in check can help support your credit score over time.

Debt consolidation loans vs. other debt payoff options

Debt consolidation loans are one option for managing debt, but they’re not the only one. Other options may help lower interest costs, combine payments or provide support from a credit counselor. Here’s how they compare.

Debt consolidation loans vs. credit card balance transfers

A balance transfer allows you to move credit card balances to another credit card, which may offer a promotional rate for a limited time. Unlike a debt consolidation loan, a credit card is revolving credit. That means your balance can change as you make purchases or payments. Your monthly payment can vary based on the outstanding balance.

Balance transfers tend to work well for smaller debts that can be paid off before the promotional period ends. If you don’t pay off the balance before that period ends, a higher interest rate may apply. A debt consolidation loan, with a fixed payment and payoff timeline, may be a better fit for larger balances or debt that will take longer to pay off.

Debt consolidation loans vs. home equity loans and HELOCs

A home equity loan or home equity line of credit (HELOC) lets homeowners borrow against their home equity, often at a lower rate than a personal loan. These options use your home as collateral, which means your home is used to secure the loan.

Missing payments can be risky because your home is tied to the loan. A debt consolidation loan doesn’t require home equity. It may be a better fit for renters or anyone who doesn’t want to borrow against their home.

Debt consolidation loans vs. debt management plans

Debt management plans and debt consolidation loans work differently. With a debt management plan, you generally work with a credit counseling agency to manage repayment of your existing debts. With a debt consolidation loan, multiple eligible debts are consolidated into a new loan, which you then repay according to the new loan’s terms.

Comparing debt payoff options

Here’s a quick side-by-side comparison of these debt payoff options.

How to get a debt consolidation loan: step by step

If you’re wondering how to get a debt consolidation loan, the process typically starts with reviewing your debts and comparing loan options. Here’s what to expect.

1. Review your debts

Start by listing each debt you’re considering combining, along with the balance, interest rate and minimum monthly payment. This can help you understand what you owe and compare it with a potential new loan.

2. Decide whether consolidation could help

Debt consolidation tends to work best when it simplifies your payments, lowers your interest costs or helps you pay off debt on a clear timeline. If your balances are small or your rates are already low, another option may make more sense.

3. Check your credit score and report

Your credit score and credit history can affect the rates and terms lenders may offer. Reviewing your credit report before you apply also gives you a chance to correct any errors.

4. Determine how much you need to borrow

Add up the balances you want to pay off and consider whether you’d like to include all eligible debts or just certain accounts. The total can help you estimate how much you may need to borrow. Our debt consolidation calculator can help you estimate potential payments and see how consolidation could affect your monthly payments and payoff timeline.

5. Compare loan offers

Interest rates, origination fees and loan terms can vary by lender, so compare the total cost of each offer before applying. Some lenders let you prequalify with a soft credit inquiry, which allows you to compare potential offers without affecting your credit score. If you decide to apply, the lender may conduct a hard credit inquiry as part of the approval process.

6. Apply for the loan

Once you’ve chosen a lender, you’ll complete an application and provide documents such as proof of income and information about your debts. The lender will let you know whether you're approved and what loan terms you're offered.

7. Use the funds to pay off your debts

Depending on the lender, funds may go directly to your creditors, or you may need to pay off each debt yourself. Either way, this step is what consolidates your existing debts into the new loan.

8. Stick to your new payment plan

Make on-time payments on your new loan and avoid taking on new debt in the meantime. Consistent payments can help you stay on track and support your credit over time.

Is a debt consolidation loan right for you?

Your debts, interest rates and repayment goals can all affect whether debt consolidation is a good choice. Consider these factors before deciding.

Here are 2 examples of how consolidation can affect what you pay over time.

When it may help: Say you owe $12,000 in high-interest debt across 3 credit cards with an average APR of 24%. If you qualify for a debt consolidation loan with a 12% fixed rate, you could lower your interest costs and combine 3 monthly payments into one. A debt consolidation calculator can help estimate your potential savings.

When it may not: Imagine you owe $3,000 across 2 credit accounts with an average interest rate of 15%. If the loan options available to you carry an 18% interest rate and a longer repayment period, consolidating could increase the amount you pay in interest over time. In this situation, keeping your existing debts may be the less expensive option.

Next steps for debt consolidation

Debt consolidation can help streamline repayment and may reduce interest costs for some people, but the benefits depend on your financial situation. Using a debt consolidation calculator can help you estimate potential savings and see how consolidation could affect your monthly payments and payoff timeline.

For more guidance, Navy Federal Credit Union’s financial counselors can help you review your debts, evaluate your options and determine your next steps.

Frequently asked questions about consolidating debt

What credit score do I need for a debt consolidation loan?

Minimum credit score requirements vary by lender. Your credit score and other financial factors can affect whether you qualify and the rates and terms you’re offered.

Can I get a debt consolidation loan with fair or bad credit?

You may be able to get a debt consolidation loan with fair or bad credit, but you may qualify for higher interest rates or fewer loan options. Approval is never guaranteed, though many lenders consider factors beyond your credit score, such as your income and existing debt.

What happens if I’m denied a debt consolidation loan?

If you’re not approved for a debt consolidation loan, ask the lender why, so you know what to address, such as lowering debt balances, increasing income or building credit history. Other options, including a credit card balance transfer or credit counseling, may still be worth exploring. You can also explore debt management and debt settlement to understand how those approaches differ.

Should I close my credit cards after paying them off through consolidation?

Keeping your credit cards open after paying them off through consolidation may help your credit by maintaining available credit and preserving your account history. Many people choose to keep their cards open and use them less, or not at all, in the future.

What happens to my old accounts after I consolidate?

This depends on the account type. Closed-end accounts, such as installment loans, generally close after they’re paid off. Revolving accounts, such as credit cards, may remain open with a zero balance. Whether to keep those revolving accounts open or close them depends on your financial goals and overall credit situation.

Will a debt consolidation loan save me money?

A debt consolidation loan may save you money if you qualify for a lower interest rate than you’re currently paying. But a longer repayment period could increase the total amount paid over time. Comparing the total cost of each option can help you determine whether consolidation could save you money.