How to Use a Personal Loan for Loan Consolidation

If you have multiple loans or credit cards with high interest rates, you might feel like you are continually paying interest and not making much headway on the principal of the debt. Consolidating those debts into one loan, ideally with a lower interest rate, can be one way to reduce your monthly payments or save on interest. Using a personal loan to consolidate debt can be one way to accomplish this goal.

This guide tells you everything you need to know about how loan consolidation works, what types of loans benefit from consolidation, and when to start the consolidation process.

What Is Loan Consolidation?

Loan consolidation, at its most basic, is the process of combining multiple debts into one. Usually, this means using a new loan or line of credit to pay off your existing debts, consolidating your multiple payments into one.

For example, imagine you have the following debt: $5,000 on a private student loan, $10,000 in credit card debt on Card A, and $10,000 in credit card debt on Card B. Your private student loan may have a high interest rate, and your credit card interest rates probably aren’t much better. You owe a total of $25,000, and each month you’re making three different payments on your various debts. You’re also continuing to rack up interest on each of the debts.

When you took out those loans, maybe you were earning less and living on ramen you bought on credit, but now you have a steady job and a good credit score. Your new financial reality means that you may qualify for a better interest rate or more favorable terms on a new loan.

A personal loan, sometimes called a debt consolidation loan, could be one way to help you pay off the $25,000 you currently owe on your private student loan and credit cards in a financially beneficial way.

Using a debt consolidation loan to pay off the three debts effectively condenses those debts into one single debt of $25,000. This avoids the headache of multiple payments with, ideally, a lower interest rate or more favorable repayment terms.

What Types of Loan Consolidation Are Available?

There are different types of loan consolidation depending on your financial circumstances and needs.

Student Loan Consolidation

•   If you have more than one federal student loan, the federal government offers Direct Consolidation Loans for eligible borrowers. This program essentially rolls multiple federal student loans into one. However, because the new interest rate is the weighted average of all your loans combined, it might be slightly higher than your initial interest rate.

•   You may also be able to consolidate your student loans with a personal loan. If you’re in a healthy financial position with a good credit score and a strong income, among other factors, a personal loan might give you more favorable repayment terms, including a lower interest rate or a shorter repayment period.

•   Consolidating federal student loans may not be right for every borrower. There are some circumstances in which consolidating some types of federal student loans may lead to a loss of benefits tied to those loans. It’s not a requirement to consolidate all eligible federal loans when applying for a Direct Consolidation Loan.

Credit Card Consolidation Loan

If you’re carrying balances on multiple credit cards with varying — and possibly high — interest rates, credit card consolidation could be one way to manage that debt.

Credit card loan consolidation is the process of paying off credit card debt with either a new, lower-interest credit card or a personal loan that has better repayment terms or a lower interest rate than the credit cards. Choosing to consolidate with a personal loan instead of another credit card means potential balance transfer fees won’t add to your debt.

General Loan Consolidation

If you have multiple debts from various lenders, perhaps some credit card debt, some private student loan debt, and maybe a personal loan, you may be able to combine these debts into a single payment. In this case, using a personal loan to consolidate those debts would mean you would no longer have to deal with multiple monthly payments to multiple lenders.

Why Consider Loan Consolidation?

There are many reasons to consider loan consolidation, but here are some to consider:

•   You want to be a minimalist. Did you join in the “pandemic purge” during this past year and a half? If your home looks less cluttered and you’d like your finances to match, you might be thinking about financial decluttering by consolidating some of your high-interest debt into one personal loan that has a lower interest rate or terms that work better for your budget.

•   Your financial circumstances have improved. Maybe you spent some time living off student loans to finish your degree, and now you’ve started your dream job. You have a steady salary and you’ve taken control of your finances. Because of your financial growth, you may be able to qualify for lower interest rates than when you first took out your loans. Loan consolidation can reward all that hard work by potentially saving you money on interest payments.

•   You’ve got sky-high credit card rates. If thinking about the interest rate on your current credit cards makes you want to hide under your desk, consolidating those cards with a personal loan may be just what you’re looking for. High interest rates can add up over the time it takes to pay off your credit card. Using a personal loan to consolidate those cards can potentially reduce your interest rate and help you get your debt paid off more quickly.

Are There Downsides To Loan Consolidation?

Using a personal loan to consolidate debt may not be the right move for everyone. Here are some things to think about if you’re considering this financial step.

Potentially High Interest Rate

Not everyone can qualify for a personal loan that offers a lower interest rate than the credit cards you want to pay off. Using a credit card interest calculator will help you compare rates and see if consolidating credit cards with a personal loan is worth it for your financial situation.

Fees May Apply

Looking for a lender that offers personal loans without fees can help you avoid this potential downside. Some lenders, however, do charge fees on personal loans. They could include application fees, origination fees, or prepayment penalties.

Recommended: Find out how a balance-transfer credit card works.

Putting Your Assets at Risk

If you choose a secured personal loan, you pledge a particular asset as collateral, which the lender can seize if you don’t pay the loan according to its terms.

Possibility of Adding to Your Debt

The general idea behind consolidating debt is to be able to pay off your debt faster or at a lower interest rate — and then have no debt. However, continuing to use the credit cards or lines of credit that have zero balances after consolidating them into a personal loan will merely lead to increasing your debt load. If you can get to the root of why you have debt, it may make it easier to remain debt free.

The Takeaway

Putting a stop to the revolving debt cycle could help place you in a better situation for future financial goals you may have. A personal loan is an installment loan, so there is a fixed end date, and if it’s a fixed-rate loan, monthly payments will remain the same for the life of the loan.

If you’re thinking about consolidating credit card or other debt, a SoFi Personal Loan is one option you may want to consider. With fixed rates and no fees, you may be able to pay off other debts with lower interest rates than credit cards or in a shorter amount of time.

Learn more about unsecured personal loans from SoFi.


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