So you’re ready to tackle debt and get the payments out from your budget, but you're not sure of the best way to do it. How can you know what option will be best for the kind of debt you're facing? This post will tackle the difference between a debt consolidation loan and debt management company so you can determine which option is best for you.
They're very different, but the differences may not seem so apparent to those who aren't used to financial terminology.
What is a Debt Consolidation Loan?
Debt Consolidation is a means to get rid of your debt fast by combining all of your debts into one big debt (often called a “debt refinance loan” or “debt consolidation loan”) at lower interest rates. You'll apply for the loan because it might offer a much lower interest rate than what you're currently paying and they'll pay off your creditors individually.
Typically, a debt consolidation loan is one large loan that you can take out with a bank or credit union that is used to consolidate all your debt (credit card, medical, car loans, etc). It allows you to roll multiple debt payments into one payment under one interest rate instead of paying multiple payments/interest rates.
A debt consolidation loan essentially “robs Peter to pay Paul.” You’re not getting rid of debt, you’re just making it easier to manage and pay off your debt.
What Can a Debt Consolidation Loan Do for Me?
A debt consolidation loan can help you pay less interest if you find the right one. And it can help you get out from under your debt faster. While it might seem backward to take on debt to get out of the debt you've gotten yourself into, it can actually help you save a lot of money in the long run.
Here's an example:
Let's say you have the following debt:
- A credit card with a $3,000 balance that charges 20% interest annually, with a payment of $100 a month;
- A student loan with a $10,000 balance that charges 10% annually, with a payment of $200 a month;
- A car loan with a balance of $5,000 that charges 15% annually, with a payment of $250 a month.
You'd be paying around $550 a month towards those debts, as well as interest from each of your debts. The credit card would wind up with $1193.50 in interest, the student loan with $2989.70, and the car loan with $1535.41.
That's a total of $5718.61 a year in interest alone.
Using debt consolidation, you'd still pay $550 a month. However, you'd only be paying $3105.93 in interest each year, for a savings of $2612.68 per year.
While a debt consolidation loan can be an excellent option for many households, it's important to remember that this is still a loan. You're still subject to monthly payments and interest rates, and you'll still experience issues if you miss a payment.
Another thing to remember – consolidation loans tend to have longer terms. A low-interest rate may mean you're paying more money for the life of the loan if you’re only paying the minimum. This is why it's important to run all of the numbers when you're thinking of playing around with your debt.
Debt consolidation loan options
Below are high-level overviews of some of the most popular debt consolidation loan lenders out there. These are online lenders (not traditional brick-and-mortar banks). As always, please do your own due diligence: rate shop for the best interest rate, read the fine print, and make sure a debt consolidation loan is actually advantageous for your own debt repayment journey before taking on any more debt.
Okay, off my soapbox now.
Upgrade offers personal loans, credit monitoring, and more. Their goal is to deliver a customer-oriented banking experience that eliminates everyday fees and offers access to low-cost cards and loans. Upgrade also wants its customers to be educated on their finances so they can build a brighter future.
They have loans available up to $50,000. These loans help you combine payments from multiple companies into one fixed payment. You’ll receive funds within one business day of loan approval so that you can start your debt consolidation journey right away.
Here's what we like about Upgrade:
- Rates provided through Upgrade are fixed and don’t change with time. You’ll know exactly what you’re paying each month and why.
- Upgrade provides customized loan options. You can choose the best one for your budget each month – there are plans available for faster payoffs as well as lower payments.
- Highly rated: customers on Trustpilot gave them 5 out of 5 stars. Bankrate gives them an overall score of 4.1 out of 5.
- Rates range from 6.98% to 35.89%, with the lowest rates requiring you to sign up for autopay and putting it towards paying off part of your debt directly.
Avant is a financial tech company “dedicated to lowering borrowing barriers for the everyday customer.” Avant offers fixed-rate debt consolidation loans to put everything into one payment.
Depending on what option you sign up for, you’ll have the loan from 2 to 5 years. Also noteworthy – you’ll have to deal with an administrative fee of up to 4.75% on top of your APR.
Your minimum required borrowing amount is $2,000, and you can borrow up to $35,000. Rates range from 9.95% to 35.99% depending on your eligibility. Your exact loan details will vary depending on your credit and laws of your state.
What we like about Avant:
- Avant offers auto-pay, so you don’t have to worry about scheduling payments yourself.
- Their funding is available the next business day after approval.
- Avant offers excellent customer service, according to many reviews on Trustpilot. Ratings on that platform averaged 4.5 out of 5 stars, according to over 9,000 reviews. Bankrate gives them an overall score of 4 out of 5.
Prosper offers debt consolidation, home improvement, and adoption loans (I didn't even know this was a thing, but awesome!). Prosper has lent out $16 billion in more than 900,000 loans and has a user rating of 4.5.
Similar to other online lenders, they give you information about what loan options are available to you within minutes after selecting your loan amount and answering a few questions on their website.
What we like about Prosper:
- Prosper offers no penalties for prepaying on your balance, which is excellent if you want to get out of your loan faster and have the means to do so.
- Debt consolidation loans with Prosper will also give you a fixed end date for when you’ll have paid off all of your debt. That means you won’t be surprised with interest rate hikes coming out of the blue, extending your payments for several months beyond what you thought you’d be paying.
Earnest issues personal loans you can use to consolidate your credit card debt. While they aren’t technically considered debt consolidation loans, they’re used in much the same way. Tomato, tomahto.
Earnest stricter eligibility requirements than other lenders. They require you to reside in one of 45 states they lend in, as well as either be a U.S. citizen or a permanent resident alien. You also can’t have any open collections accounts or carry large amounts of credit card or personal loan debt. You’re required to have saved up two months of expenses as well.
BUT they also have the lowest rate on here, which is why they're one of my favorites to recommend to readers although I've personally never used a debt consolidation loan. (Read more about how I pay off debt here.)
What we like about Earnest:
- The company allows you to choose how much you want to pay each month, as well as the length of the loan you acquire.
- You can increase your payment amount whenever you want, and pay off your loan sooner than anticipated if you would like with zero prepayment penalties. They really want you to reduce debt quickly and do not want to penalize you for doing so.
- Rates start at 5.99% and go up to 17.24%. These are lower rates than you'll find with any of the other lenders mentioned on this list. A high-end cap of 17% is a very good rate for a debt consolidation loan by the way.
- There’s also no origination fee for your loans or any other charges for that matter. Your money doesn’t have to go towards anything but paying off your debt.
Credible is a financial company that offers student and personal loans as well as credit cards.
They also offer a service not provided by other lenders, which is to help you directly compare offers from other lenders, including several on this list. You can use this option without impacting your credit score.
The company has a 4.5 rating on Trustpilot, but do your homework: it has a much lower score of 1.5 on Consumer Affairs. Credible rates range from 5.99% to 35.99% and has debt payoff rates of 24 to 84 months.
What we like about Credible:
- Credible comes with no fees, and you can reach out to their client success team at any time to get support.
- Credible offers the most significant loan limit, with ranges from $1,000 to $100,000.
Lendkey is a fintech company that uses cloud technology to match lenders with banks and credit unions. Their goal is to create accessible borrowing options for everyone because connecting borrowers directly with lenders allows for lower interest rates and direct connection. This is more for those looking to refinance student loans or consolidate student loan specific debt.
Refinancing your student loans can help you reduce interest and get a better rate than when you were in school. As you’ve worked and built up credit, your credit score is likely to have improved, meaning you’re eligible for a reduction in the rates you currently pay.
Lendkey has provided $3.1 billion in loans and helped over 99,000 borrowers. On their site, Lendkey is rated 4.7 out of 5. On NerdWallet, they have a rating of 4.5 out of 5. Loan terms start at five and go all the way to 20 years.
What we like about LendKey:
- Rates available through Lendkey go as low as 1.9% for variable and 3.49% for fixed APR. VERY GOOD RATES.
- Lendkey only offers debt consolidation for student loans. Credit card and other personal loan refinancing is not available through Lendkey.
Debt Consolidation Loan: Common FAQs
Is it a good idea to get a debt consolidation loan?
Whether or not this method is best for you is highly dependent on a few factors:
- How much total debt you have
- What your current interest rates are
- What your financial goals are
Going with a debt consolidation loan won't get rid of your debt, it just allows you to manage your debt easier, and hopefully, pay less interest.
When choosing a consolidation loan, make sure you get a large enough loan to cover all your debts but with a lower interest rate than the creditors that currently hold your debt.
On the other hand, if you can’t find a consolidation loan with an interest rate that’s substantially lower than what you’re paying now (for example, you’re paying 16% on your credit cards/personal loans but the bank won’t give you a loan any lower than 20%) then a consolidation loan isn’t worth your time.
Will a debt consolidation loan hurt my credit score?
On the contrary, if you’re using a consolidation loan to close out balances on revolving credit like credit cards and home equity loans then it can help your credit score significantly!
This is because a consolidation loan pays off your balance with those cards/loans and moves those balances into your new consolidation loan.
…..So, on your credit report, it looks like your credit utilization went down. And credit utilization is almost 30% of your credit score.
Just as long as you don’t start closing your oldest credit cards and lines of credit, then your credit score shouldn’t be affected too much by taking out a consolidation loan.
A few other credit-related things to consider with debt consolidation loans:
- Closing revolving credit accounts will undoubtedly hurt your credit score as it causes your “credit utilization rate” to increase. This is because there are fewer accounts open and a higher debt/credit ratio which causes scores to go down.
- Something that will affect your score negatively is the hard inquiry that needs to occur when initially applying for the consolidation loan.
- That all being said, if you fall behind on payments for your consolidation loan, then it will hurt your credit just like it would for any credit account.
- If you use a debt consolidation loan to pay off loans (such as an auto loan or student loan) then those loans will show as closed once you hit a zero balance, and this could affect your score.
- However, your new consolidation loan will show as a new account open and any revolving credit accounts will show as a zero balance (as I talked about earlier).
The TL:DR: A consolidation loan will hurt (at first) and then greatly help your credit score..at least when it comes to consolidating credit card debt. This is only as long as you keep revolving account balances at zero but open, and you stay on top of payments to your new consolidation loan.
Can I get a debt consolidation loan with poor credit?
Yes, but if you have a lower credit score due to late payments, defaults, bankruptcy, high credit utilization, or any other negative reason, it may be hard for you to find a loan with an interest rate that beats the ones you already have.
A credit score below 660 indicates poor credit, meaning the loan you are offered may have an interest rate that is above that of the credit cards/loans you are trying to pay off with it, 28%+ in certain situations.
This isn’t to say it’s impossible to get a debt consolidation loan with poor credit, but it may not be your best option and you may need to shop around.
Is it Smart to Get a Personal Loan to Consolidate Debt?
Personal (unsecured) loans tend to have higher interest rates than specific debt consolidation loans but if you can find one that has a better interest rate than what you are paying on your current debt, then a personal loan can work. As I say in my course, The Debt Master Plan, lowering interest is the right way to go.
However, low-rate personal loans are usually reserved for those with excellent credit (750+).
What is a Debt Management Company?
Debt management companies are very different from debt consolidation loans. For one, they are not banks.
These companies create a plan for you to get your debt paid off. They work as a “middle man” with your creditors to reduce interest rates and monthly payments (this is sometimes referred to as “debt settlement”). Most plans will take around 3-5 years for you to pay off.
Debt management companies create programs that help you pay off unsecured debts like medical bills, student loans, and credit card bills while helping you to regain control of your finances through education and financial planning.
- Many of these companies will help you create a plan that works around your needs and income.
- You'll know ahead of time what monthly payment you need to make on your debts.
- For those who aren't familiar with budgets, or who don't have a lot of experience in managing finances, working with these companies is a great way to create realistic budgets and goals.
- Credit collectors are also less likely to call you, as they can see that you are working on paying them back.
- You'll want to be careful when deciding to work with a debt management company. Make sure there are no complaints against them from the Better Business Bureau, or the state Attorney General's office.
- You'll also want to make sure the company is licensed to help you. And be very careful about hidden fees along the way.
- One of the most significant downsides of using a debt management company is that your credit score is likely to drop.
- Because these companies renegotiate your financial obligations, they can create late payments or close accounts that you have a good history with. However, this change isn't usually long term and may help you improve your credit in the long run.
Hear from someone who used a Debt Management Program
Full disclosure: I've never used a debt management company, although I have used a consolidation loan to pay off higher interest balances in the past. It's a great way to save money on interest if you have a solid financial history and good credit.
But I wanted to hear about the benefit that these debt management companies can provide to those who are – literally – drowning in debt. My courageous friend, Robin, paid off $30,000 dollars of debt through one such program, and I personally believe this video is one of the best in the “Awkward Money Chat” series.
In the video below, Robin talks quite candidly about how to pay off credit card debt, and her story is amazing because she was successful!
How to Decide Which is Best For You
Here's the big difference between the two we've spent the last 20 minutes dissecting:
- A debt consolidation loan is a tool to help you consolidate all your debt payments into one loan with one interest rate.
- A debt management company provides you with a plan of how to pay all your debt down.
If you believe you can manage your debts on your own, and you just want to decrease the overall amount of interest you end up paying each year then a debt consolidation loan is the way to go.
However, if you're unsure of how to change your financial behavior, and you need help figuring out how to take control of your debt situation, a debt management company can help you do that. They can act as a middleman between you and your creditors, and help ease the stress of dealing with collection departments so you can focus on paying down the debt.
There is a misconception that debt consolidation and debt management is only for people who are:
- In dire straits
- Have lost everything
- Are being harassed by creditors at every hour of the day
But this isn’t the case. These fixes are popular options for those struggling to keep up with multiple student loan payments, a mortgage, medical bills, credit card, and/or personal loan debts. Debt doesn't have to be this unmanageable thing you live with your whole life. The good news is; there are options and help available for those who want to live a debt-free life.