Debt Consolidation Loan vs. Personal Loan: What's the Difference?

Juggling multiple debts at the same time means several due dates and minimum payments. Rolling them into one new loan can simplify things, and might even cost you less in the long run. A debt consolidation loan is usually just a personal loan marketed for that purpose. Here’s where the two differ, and how to tell whether consolidating will save you money.

What's the difference between a debt consolidation loan and a personal loan?

There’s very little difference between the two. Lenders often market personal loans as “debt consolidation loans” when the money is meant to pay off other balances. In reality, a personal loan can be used for all kinds of things, and a debt consolidation loan is a personal loan targeting just one of them.

Read more >> How Debt Consolidation Loans Affect Your Credit

What is a personal loan?

A personal loan gives you a lump sum of cash that you repay in monthly installments over a set term. Most personal loans have fixed rates and fixed payments, which means they won’t change over time.

Most people use them to:

• Consolidate debt
• Cover an emergency
• Pay for a large expense

You can apply for one through a bank, a credit union, or an konline lender. The lender looks at your credit report to decide whether to approve you and what rate and term to offer.

Most personal loans are unsecured, which means there’s no collateral. Some are secured by a savings account, a vehicle, or another asset. A secured loan can be easier to qualify for, but the lender can take the asset if you default on your loan.

It’s usually a good idea to get pre-approved with multiple lenders so you can compare rates, fees, repayment timelines, monthly payment amounts, and customer reviews. This is important since some personal loans have fees and other potential downsides to consider.

Read more >> What Credit Score Do You Need for a Personal Loan?

What is a debt consolidation loan?

A debt consolidation loan works the same way as any personal loan. You use it to pay off several debts and then make one monthly payment at one rate.

The goal of debt consolidation is to:

• Simplify your loan payments to one payment and one due date, instead of several.
• Get a lower interest rate to reduce your overall borrowing costs

Consolidation moves your debt, but it doesn’t eliminate it. Lower monthly payments may come with longer terms, which can cost more overall. If you use one to pay off credit cards, those cards may stay open. A new balance on top of the loan payment can put you further in debt.

Using a home equity loan

Some homeowners consolidate debt with a home equity loan. That’s a second mortgage borrowed against the equity you’ve built in your home, or the gap between what your home is worth and what you still owe on it. The rate may be lower than a personal loan’s, but the trade-offs are bigger:

• Your home becomes the collateral. Card debt that was unsecured becomes debt secured by your house. If you can’t repay, you risk losing your home to foreclosure.
• You’ll pay closing costs, similar to those paid for your original mortgage.

Federal law gives you three business days after closing to cancel most home equity loans with no penalty. But before you put your home behind a secured loan, it’s worth understanding the risk.

Read more >> Should You Consolidate Credit Card Debt?

‍They’re usually the same product. A debt consolidation loan is typically a personal loan marketed for that use. Same structure, same rates, different label. Some lenders will pay your creditors directly, which is convenient, but it doesn’t make it a different loan. Compare both against each other on rates and terms, not on the name alone.

Who debt consolidation loans are best for

Consolidation is more likely to help if:

• You can qualify for a lower rate than what you’re paying now. Your credit is a big factor. With a lower score, offers may not beat your current rates. If they don’t, consolidating won’t save you money.
• Multiple monthly payments are the problem. One payment is easier to track than several.
• The new payment fits your budget. A consolidation loan can have higher monthly payments than your combined minimums, especially on a shorter term. Compare actual payments before you sign.

Key differences between debt consolidation loans and personal loans

No matter which one you apply for, when determining your interest rate and loan term, lenders will look at:

• Your credit score
• Your payment history on past accounts
• Your income
• Your debt-to-income ratio (DTI), or the amount of debt you have compared to your income.

How each loan type affects your credit

Prequalifying with a lender usually requires a soft credit inquiry, which doesn’t affect your scores, so you can prequalify with several lenders to compare offers. A full application triggers a hard inquiry, which typically lowers your credit score by a few points temporarily. While FICO groups inquiries for mortgages, auto loans, and student loans within a tight shopping window, personal loan inquiries count separately. Apply fully only to those you’re interested in.

Other ways a personal loan can affect your credit:

• Your card balances. Paying off cards with a personal loan lowers your credit utilization, or how much of your available credit you’re using. That can help your score while balances stay low, and keeping the paid-off cards open helps keep utilization down.
• Payment history. The new loan shows up on your credit report. On-time payments add to your record each month, while missed payments can negatively affect it.
• Debt-to-income (DTI). If the loan replaces debt you pay off, your DTI may not change much. If balances build back up on the cards, DTI rises, and that can make it harder to qualify for credit in the future.

Read more >> The Importance of On-Time Payments in Building Credit

Which should you choose to consolidate debt?

Since the loans are the same type of product, the real choice is how to consolidate:

• Start with free counseling. A nonprofit credit counselor can review your debts and budget, helping you put together a plan at no or low cost. Call the National Foundation for Credit Counseling at 800-388-2227.
• Personal loan. A loan works best when your credit gets you an APR that’s less than what you pay now. Compare the APR, and not just the interest rate, because origination fees can be high.
• Home equity loan. This type of loan offers the lowest rate for some homeowners, and the highest risk. Talk with a licensed attorney or credit counselor before you use your home to secure card debt.

Whichever you choose, the test is the same. Add up what you’d pay in total, including fees, and compare it with what you’d pay by keeping your current debts. If the number isn’t lower, it may not be worth the simplicity.

Bottom line

A debt consolidation loan is a personal loan used to pay off other debt. It helps when the new rate beats your old ones.

Your credit sets that rate. A Kikoff Credit Account reports your on-time payments to Equifax, Experian, and TransUnion, so each month adds to the record lenders price from. There's no credit check to sign up, and plans start at $5 a month.