Taking a Debt Consolidation Loan? Consider These Factors First

Consumer debt has skyrocketed by $2.3 trillion since 2009 – the apex of the Great Recession – rising to $14 trillion in 2019, according to data from Experian. Part of that debt is understandable, as Americans earned more money and spent more money as the economy grew significantly after the economic crash of 2008-2009.

But debt is debt and it has to be paid off. That’s where a debt consolidation loan comes in handy. Debt consolidation loans do just what they suggest – bundle multiple debt into one more manageable, ideally borrowed at a low interest rate.

“Consumers use a debt consolidation loan to pay off high-interest debt replacing it with a single loan with a lower interest rate,” said Randall Yates, chief executive officer at The Lenders Network, in Dallas, Tx. “Not only will a debt consolidation loan help get you out of debt quicker and save you money, but it will improve your credit score.”

That’s due to a consumer’s credit utilization ratio – the amount of available credit used. “When you pay off your credit card debt with a consolidation loan your credit score will improve significantly, assuming you keep the cards open and keep the balances low,” Yates said.

RELATED: How Do Credit Utilization Ratio and Debt-to-Income Ratio Affect My Credit Score?

A Debt Consolidation Action Plan

What are the key considerations to mull over when taking a debt consolidation? And what steps should you take to get the best debt consolidation loan experience?

Here are a few factors that have to be considered before signing on the dotted line.

Consider the upfront costs of a loan. Borrowers should think twice about consolidating debt with a personal loan if the up-front costs are hefty.

“One of the primary goals of debt consolidation is saving money, which is why it’s so important to sit down and do the math to make sure you still come out on top,” said Nishank Khanna, chief financial officer at Clarify Capital in New York City, N.Y. “When you factor in application costs, origination fees, and any prepayment penalties, you might be surprised to realize you aren’t saving nearly as much as expected, or worse, you end up losing money by consolidating.”

Consider interest costs, too. A lower monthly payment might seem like a steal, but if you’re extending the length of your loan, you might end up paying more interest over time.

“It’s important to remember that a lower interest rate doesn’t always equate to more money in your pocket,” Khanna said. “Interest rates and loan terms work in tandem with each other, meaning that a low-interest rate on a loan that’s paid back over a long period of time might cost you more than a high-interest rate, shorter-term loan.”

RELATED: How To Know If You Have Too Much Debt

Will it accommodate your household budget? One of the most important considerations to look for in a debt consolidation loan is whether the loan fits into your budget.

“Assuming the consolidation loan provides a lower interest rate and saves you money on interest consumers should be aware of the high monthly payment,” said Adem Selita, founder of the Debt Relief Company in New York City. “When consolidating credit card accounts into a debt consolidation loan, it’s extremely likely that your monthly payment will increase substantially, as opposed to your credit card minimum payments.”

Will the loan bundle up all your household debts? It’s very important to calculate whether the consolidation loan will consolidate all of your debts.

“If you’re only able to consolidate half of your debt, a debt consolidation loan may not be the best financial move for you and may make things more difficult,” Selita said.

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• How Does Debt Consolidation Hurt Your Credit
• Debt Consolidation vs Debt Counseling
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Your Best Tips in Getting a Debt Consolidation Loan

Make sure you have the best credit score possible before applying for a consolidation loan, before you apply for a debt consolidation loan.

“These loans are not very easy to qualify for, since you are combining smaller debts into one larger loan,” Selita said. “Due to the size of the loan, lenders will look to be more risk averse and typically seek “good credit applicants.”

Boost your credit worthiness by leveraging a credit score acceleration tool like Experian Boost to pump your credit score for the short-term. In addition, make sure your credit utilization rate is as low as possible before you apply for the loan.

“One easy way to do that is to zero out any balances on smaller credit card accounts you have and make sure they are reporting the lowest possible utilization on your credit report at the time of application,” Selita said.

Also, don’t be afraid to negotiate.

“Often times you can negotiate down origination fees and any other finance charges including in the loan,” Selita noted. “Try to get a loan that has no pre-payment penalties. This way, if you do get a windfall of cash, you can pay the loan off early and forego the rest of the interest charges due.”