Basics of Loan Consolidation

Basics of Loan Consolidation

If you have existing debt from multiple sources, including personal loans, it may be beneficial to consolidate it by taking out a new loan. A consolidation loan combines all that debt into a single loan that is larger but more manageable.

Even though debt consolidation offers many advantages for the borrower, there are also numerous associated risks. Let’s go over the basics of debt consolidation you should know.

Definition of loan consolidation

Loan consolidation refers to the act of consolidating your debt into one larger loan. This may be done by obtaining a new loan–most often, this would be a personal loan. This can be done with any creditor who offers loan consolidation options, such as a bank, credit union, online lender, or even the federal government.

Types of loan consolidation

There are many kinds of loan consolidation. Here are a few you might encounter.

Personal loan

Taking out a personal loan is the most common method of consolidating debt. You would need to sign a loan agreement with a creditor. The agreement will designate brand-new terms, including the repayment schedule, interest rate, and any additional fees.

Once you’ve consolidated your debt into one personal loan, you will need to pay back this personal loan according to your new contract.

Balance transfer credit card

Another common strategy to tackle debt consolidation is using a balance transfer credit card. This is a kind of credit card transaction that lets you move debt from one account to another. It can help you save money by helping you move your debt to a new credit card with a lower interest rate.

You can expect balance transfers to come with a balance transfer fee, which typically ranges from 3% to 5% of how much you’re transferring. Also, the new credit card limit might prevent you from transferring the full balance that you would like.

Fortunately, you may be able to find a card with a balance transfer promotion–usually, this would be something like an introductory 0% annual percentage rate (APR) on balance transfers. Other credit cards that can be advantages for a balance transfer include those that have $0 annual fees or $0 balance transfer fees.

Debt consolidation service companies

If you want to consolidate your debt, another option is to find a company specializing in debt consolidation services. They may guide you toward an effective, structured debt repayment plan.

Government debt consolidation programs

If you have taken out student loans, there are federal student loan debt relief programs that may be able to help you relieve your financial burden. For example, you may apply for a Direct Consolidation Loan that helps you combine multiple student loans into one. This option allows you to get a loan with a fixed interest rate that is the average of your other loans. There is also no application fee associated with this federal loan consolidation option.


Benefits of loan consolidation

Simplified debt

If you have debt from multiple sources, it can be tricky to keep track of everything. One mistake could create a snowball effect, making it substantially harder to manage your debt.

You need to be aware of the different creditors, monthly payments, interest rates, and more. Being late on your repayment schedule for any one of them can lead to frustrating fees and penalties.

That’s where a consolidation loan comes in. It enables you to combine all your debt so that you don’t have to worry about each and every one of them individually. Instead, you just have an overall amount of debt, in the form of one loan you need to repay.

Better rates

If you manage to find a good loan consolidation option, you could potentially save money on interest. This definitely depends on whether you qualify for debt consolidation loans with favorable terms.

More time to repay debt

Debt consolidation can give you significantly more time to repay your accumulated debt since you roll previous debt amounts over to your fresh new account with a new creditor.


Risks of loan consolidation

Credit score damage

Your credit score is the three-digit number generated by FICO or VantageScore. It is used by creditors to assess your creditworthiness. If your credit score is low, it can be very challenging to be approved for loans or credit extensions. One of the biggest problems of loan consolidation is that it can hurt your credit score by a handful of points. Getting your credit checked when you apply for a loan can lower your score by 5-10 points each time.

For individuals whose credit scores are in a shaky state, it is generally advisable to be careful about debt consolidation. Weigh the pros and cons of consolidating debt in your particular situation before making the ultimate decision. If you predict that you might need additional funds from a loan in the immediate future, credit score damage may deter lenders from lending you money.

Worse rates

While loan consolidation could give you an overall interest rate that is preferable, this is not guaranteed. You may be unable to find a lender who is willing to give you good enough rates for debt consolidation to be worth it.

Lenders look at various factors when determining the loan terms they are willing to grant you. These factors include your credit score, income, employment, and recent credit behavior. If you have a consistently bad track record of repaying your debt, even a debt consolidation lender might be reluctant to give you good rates.

Extra fees and charges

Depending on which loan consolidation option you choose, you might incur various fees just for attempting it, such as origination fees and balance transfer fees.


Loan consolidation providers

Research can help you choose the debt consolidation lender that suits your needs the best. Here are some of the best, most reputable companies that provide loan consolidation.


The loan consolidation provider, LightStream, is known for providing borrowers with many personal loan choices that have good rates and flexible repayment plans. With the option to choose long loan repayment terms, you can take more time to save up money and repay your debt in a manageable way that doesn’t suffocate your finances each month.

LightStream loans don’t usually have prepayment penalties, which means you can pay the loan off early. There is also no origination fee for taking out personal loans from LightStream, which scales in how beneficial it is based on how big a loan you need since many origination fees are a percentage of your loan amount.

You may be able to take out a loan of up to $100,000 depending on factors such as your credit behavior and score. All of this can be processed online with fast funding if you get approved, making LightStream a convenient choice for those who want to quickly consolidate their debt.

Because of the numerous advantages offered by LightStream, it is considered by many to be the best overall loan consolidation company today.

Marcus by Goldman Sachs

This is a division of the Goldman Sachs Bank. They offer a debt consolidation option that is very convenient because Marcus will directly pay off your other creditors. This direct payment saves you time and stress as you won’t have to transfer money or write the checks to your old creditors by yourself.

Compared to LightStream, Marcus offers personal loans of lower amounts. Marcus offers up to $40,000 and generally has payoff periods from 36 to 72 months. This can give you a good amount of time to manage your overall debt.


Discover provides individuals with three available options for debt consolidation: personal loans, balance transfer credit cards, as well as home equity loans. You can consolidate numerous kinds of debt, such as student loans, medical expenses, credit card bills, and more. This flexibility can be helpful for those who are exploring their loan consolidation options.

If you go with a home equity loan with Discover, you may be able to choose a long repayment term of up to 30 years. Their interest rates are usually fixed and reasonable, allowing you to have a stable repayment schedule. Loan amounts vary depending on your creditworthiness and what kind of loan consolidation plan you choose.

Discover can make the debt consolidation process more convenient through direct payment to your other creditors and an online loan consolidation calculator. The application process for loan consolidation with Discover is also online and streamlined, which means if you are approved, you can receive funds within the next few business days.


If you have poor or fair credit, this might be the loan consolidation choice to consider. FreedomPlus has a lower credit score requirement than many other companies: you need a minimum of 620 to apply.

FreedomPlus only lets you consolidate debt through a personal loan. The company offers direct payment to creditors, simplifying the loan consolidation process for you. Depending on your creditworthiness, income, and other factors, you might be able to receive a loan of up to $40,000.

Eligibility criteria

Different creditors have different eligibility criteria. In general, you want to meet the following requirements:

Good credit: If you have a credit score of over 670, it becomes easier to be approved for loan consolidation options. Lenders will see you as more creditworthy, which means there are lower risks involved in lending you money.

Employment and income: Generally, lenders want to see proof that you have a stable income and employment. If you are unemployed, it can be harder for creditors to approve you for a debt consolidation loan.

Existing debt-to-income ratio: Even if you have a high income, if you have a significant amount of debt you want to consolidate that makes up for over 43% of your income, creditors might reject your applications.

Loan type: Creditors might have requirements for and restrictions on what loan types you can consolidate. For example, you might not be able to consolidate student loans with your credit card bills, depending on your desired creditor.

Age requirement: Not every state allows minors to be held liable for debt. Still, it’s worth noting that if you are not yet 18, you generally won’t be allowed to take out loans for debt consolidation.

Interest rates

Your new interest rate can vary greatly depending on various factors. It can be anything from 5% to 36% based on your creditworthiness, debt amount, and repayment terms.

Since you’re consolidating the existing debt you owe, it’s important to consider whether the new interest rate you get is worth it. Not every loan consolidation plan has terms that benefit you. Like with taking out personal loans for other reasons, make sure you carefully review your loan consolidation agreement so that you’re aware of the risks and benefits.

Repayment options

Many loan consolidation creditors will give you ample time to repay the debt. They are aware that it’s unlikely borrowers can repay consolidated debt in a short amount of time. You can get a repayment plan that grants you up to 7 years to repay the loan.

You will likely be making fixed payment installments every month until the debt has been repaid.

Loan consolidation process

The loan consolidation process first requires you to find a creditor that offers debt consolidation services. This can be in various forms, such as personal loans, home equity loans, or balance transfer credit cards. Regardless of the type, you will need to fill out an application (either in person or online) with information about yourself and your debt.

If you are approved for the loan consolidation option, you will need to sign a contract agreeing to the designated terms outlined by your creditor. After that, if your new creditor offers direct payment to existing creditors, they will repay that debt for you. Otherwise, you will have to use the funds you receive to repay your debt by yourself.

Finally, you are left with a single, larger loan that you will need to repay according to the agreed repayment terms.

Fees and charges

Depending on which creditor you approach for loan consolidation, you may incur various fees and charges. Here are a few of the more common kinds of fees and charges that borrowers encounter when consolidating debt.

Origination fee: When you close a loan and lock in the terms, lenders might charge you an origination fee. This is a one-time charge that could either be a flat fee or a percentage from 0.5% to 10% of your loan amount. If you have a ton of debt, be careful when taking out a loan with an origination fee, since a 10% fee could make quite the hefty expense.

Balance transfer fee: When creating a new balance transfer credit card account, there is usually a fee you need to pay for transferring old balances. This fee would be added to your total balance in your new account.

About The Author

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Ru Chen

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Ru Chen is a content writer with several years of experience in creating engaging and well-researched articles. She mostly writes about business, digital marketing, and law. In her free time, she can be found watching horror movies and playing board games with her partner in Brooklyn.

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