Debt Consolidation: How It Works + 5 Best Loan Options

Do you have a mountain of debt and worry about money? You are not alone. Money is the most common form of stress. According to the American Psychological Association, 72% of adults stress about money, paying rent, or feeling overwhelmed by debt.

Several studies have demonstrated a cyclical link between financial worries and mental health problems such as depression, anxiety and substance abuse. Learning to cope with financial stress and effectively manage your financial situation can help you feel more in control of your life, reduce your stress, and build a more secure future. Try some of the following tips to get on the road to recovery.

Looking for a debt consolidation loan?

We may be able to help. It’s easy and free to find out.

Best Debt Consolidation Loans

  • Upstart
  • PenFed Credit Union
  • RocketLoans
  • SoFi
  • Lightstream

What You Need to Know About Debt Consolidation

Editor’s note: If you already know how debt consolidation works, skip to the best options to choose from by clicking here.

Debt consolidation rolls all outstanding debts into one monthly payment, usually with a lower interest rate. Because you’re rolling multiple debts into a single loan, this is referred to as “consolidating” your debt.

You take on a new, larger loan and use that money to pay off other existing loans with higher interest rates. It also streamlines multiple credit cards into one payment, making it harder to miss a payment or incur a late fee.

Debt consolidation could be a good option for borrowers who have a lot of debts with high or variable annual percentage rates. If you can secure a low fixed rate, this new loan can save you a lot of money over the life of the loan.

The main goal of debt consolidation is to pay off high-interest debts first, like credit cards and payday loans. However, a lower interest rate isn’t always guaranteed. Debt consolidation will depend on the borrower’s credit score, income, and other factors. The FICO model gets used in about 90% of lending decisions which rates your character, capital, and capacity.

Pro tip: Debt consolidation may not always be the best choice for everybody. Borrowers with poor credit scores face rejection or could end up with even worse terms than their existing debts. You will need to know each card’s interest rates and balances to see if debt consolidation is right for you.

Debt consolidation won’t wipe out your balance. It just rolls it into one large monthly payment. If you have decent to good credit, a new loan with a lower interest rate will save you money.

What types of debt can I consolidate?

Debt consolidation can pay off all kinds of debt — including credit card balances, medical bills, etc. Unlike credit cards, which are a form of revolving credit, debt consolidation loans are installment loans.

Top 5 debt consolidation loans

Here are the best debt consolidation companies we recommend.

Disclaimer: Some or all of the products featured in this article are from our partners who compensate us. This may influence which products we write about and where and how the product appears on a page. However, this does not influence our evaluations. All opinions are our own.

Best overall: Upstart

  • APR: 4.37-35.99%
  • Loan amount: $1,000 up to $50,000
  • Loan terms: 36-60 months
  • Credit check: Yes, they make a hard inquiry after a profile submission to verify you meet their credit minimum
  • Minimum credit score: 580
  • Application process: Apply online. The Upstart loan timeline includes around 1 to 14 business days to get approved for an Upstart loan and another 1 to 3 business days to receive the funds after approval.
  • Prequalification: Upstart says borrowers can prequalify and see their rate in five minutes. They can expect approval to take one business day.

Other noteworthy information: No prepayment penalty, origination fee that can be up to 8% of the loan amount, no mobile app, and no co-signed, joint, or secured loans offered. The minimum income requirement is $12,000.

PenFed Credit Union

  • APR: 4.99%-17.99%
  • Loan amount: $600 up to $50,000
  • Loan terms: One to five years
  • Credit check: Yes, applicants can prequalify with a soft credit check
  • Minimum credit score: None but best for 690 or better
  • Application process: Apply online. 
  • Prequalification: Borrowers must belong to the PenFed Credit Union

Other noteworthy information: Accounts can be managed online or via mobile app and allow joint applications. Available in all 50 states.

Rocket Loans

  • APR: 5.97%-29.99%
  • Loan amount: $2,000-$45,000
  • Loan terms: 36-60 months
  • Credit check: Yes, the prequalification process only requires a soft credit check
  • Minimum credit score: 580
  • Application process: Online and receive funds in two to four business days.
  • Prequalification: Offers same-day approval, and same-day funding may be possible

Other noteworthy information: No prepayment penalty, rate discount on autopay, no co-signers or co-applicants.


  • APR: 5.74%-35.99%
  • Loan amount: $5,000 up to $100,000
  • Loan terms: 24-60 months
  • Credit check: Yes, a hard credit pull, which may impact your credit score, is required if you apply for a SoFi product after being prequalified
  • Minimum credit score: 680
  • Application process: Their loan applications begin our initial review within one business day, and most of our applications are completed within two business. The application process is completed entirely online
  • Prequalification: Yes, online with a soft pull

Other noteworthy information: low rates, no origination fees, no prepayment fees, or other “hidden fees,” You can view rates in as little as 60 seconds. You have access to customer support seven days a week.


  • APR: 2.49% to 19.99%
  • Loan amount: Up to $100,000
  • Loan terms: 24-84 months
  • Credit check: Yes
  • Minimum credit score: 670
  • Application process: Apply online and receive a response during business hours which typically won’t take longer than two business days.
  • Prequalification: None

Other noteworthy information: No origination fees, prepayment penalty, or late fees. Joint application option and autopay discount. You can get your money the same day your loan is approved.

How to Qualify for a Debt Consolidation Loan

A debt consolidation loan is usually the simplest and most inexpensive way to consolidate debts. The higher your credit score, the lower your interest rate will be, but don’t despair if your credit score is not great. There are even personal loan options for people who’ve declared bankruptcy. You’ll just pay a higher interest rate. And debt consolidation can help your credit score in the long run.

How to apply

Here are the steps you need to follow:

  • Check your credit scores. See where you can improve your score. You can do all of this for free
  • Compare loan offers to find the ones with the best rates and terms
  • Complete the application process online. You will get a soft pull on your credit to estimate the rate and payment terms. Comparing rates will not harm your score
  • Wait for approval once you have done an official application and a hard pull on your credit report
  • Wait for the money to be deposited directly into your bank account. The money can come as quickly as the next business day
  • Once approved, use the new loan to pay off your high-interest loans first

You will want to compare loan origination fees from lender to lender. The origination fee will increase your total debt amount.

Some lenders pay your debt directly to the credit card company. Some will deposit it directly to your account for you to be responsible for paying your debt.

Do it as soon as the money hits your bank account if this is your responsibility. It will not help your financial situation if you spend your new debt on other expenses instead.

Use a debt consolidation calculator

Figure how much you’re paying each month and how much you can afford in monthly payments. Calculate the total loan amount you need to consolidate everything into one charge and the loan term to keep the minimum payment required each month within your budget. Add in an estimated interest rate and the number of months to pay the debt.

Use this example of a debt consolidation calculator if you’re struggling to make your own.

When you apply for a debt consolidation loan, lenders will assess your creditworthiness: Credit score, credit history, income, debt-to-income ratio, credit utilization ratio, and other financial details to determine interest rates, loan payment terms, and lending amounts. Your credit score will matter. 

These are the average FICO score ranges:

  • Good credit: 670 to 739
  • Average credit: 580 to 669
  • Poor credit: 300 to 579

There are loans geared toward borrowers with fair credit or borrowers with bad credit. If you are on the cusp, consider improving your credit score to get a better rate. One point may be all you need to save more on the life of the loan.

Want to know more about debt consolidation? Check out this video:

Other debt consolidation options

Here are several other options to consolidate debt.

Personal loans

A personal loan is a loan from a bank, credit union or online lender. These loans are issued in a lump sum, deposited into your bank account, and considered a form of installment credit. It is repaid in fixed monthly payments, usually over two to seven years.

Personal loans can be secured or unsecured loans. Secured loans are like a mortgage where the house acts as collateral for the loan or a car title for a loan. 

An unsecured loan doesn’t involve any collateral. The only assurance a lender has that you will repay the debt is your creditworthiness and your word. These can be student loans and credit cards. These are considered higher-risk loans.

401(k) Loans

With a 401(k) loan, you borrow money from your retirement savings account, so it’s not a loan. Depending on your employer’s plan, you could take out as much as 50% of your savings and a maximum of $50,000 within 12 months. You might have to pay back the entire loan balance if you lose your job.

Credit card balance transfer offer

A balance transfer will be your best low-interest option if you can qualify because of the 0% introductory rate for up to 21 months on some cards. Credit card balance transfers won’t work for everyone; your credit score must be high enough to qualify. You can pay off your debt within the introductory period saving you a ton of money in interest. You need a minimum of 690 to qualify. You move high-interest rate credit card balances to the new 0% introductory rate card. The new card will allow you to transfer up to 80% of your total credit line. You’ll have to pay a transfer fee, usually around 3-5% of the total amount you transfer.

Many credit card companies will rescind the introductory rate if you aren’t making on-time payments, so set up an autopay to ensure that you’re paid up by the due date each month.

Payday alternative loan

Credit unions offer these loans and cost considerably less than a payday loan. It allows 12 months to repay, and loans can be up to $2000. The maximum APR is 28%, with an application fee of no more than $20. Depending on the credit union, you have to be a credit union member for at least one month or six months. You can receive a maximum of 3 loans within six months. Most don’t require good credit but just the borrower’s income and ability to repay the loan.

Tap into your home’s equity

A home equity loan or line of credit (HELOC) allows homeowners to use their property as collateral to secure a low-interest loan. Loan rates are usually lower than debt consolidation or personal loans because you’re technically using your own money.

Reverse Mortgage

If you’re 62 or older, you have another option — a reverse mortgage. The reverse mortgage allows you to borrow money against the equity in your home with no payments while you live in the house. It is repaid when you pass, sell or move into a retirement home. The Federal Trade Commission (FTC) has a handy guide explaining the pros and cons of taking out a reverse mortgage. 

Consider a mortgage refinance

A mortgage refinance means trading your old mortgage for a new one. You can pull cash out in the refinancing if you have enough equity built up in the home and use this to pay off your high-interest debt.

Pros and cons of consolidating your debts

Before jumping in and applying for loans, it’s essential to consider debt consolidation’s potential benefits and drawbacks.

Simplifies your financesThere will be a credit check and a high credit score is required
You pay off debt fasterYou could end up paying more in interest over the life of the loan
It may boost your credit scoreIt won’t solve your problems if you don’t correct your financial habits
Gives you a fixed repayment scheduleUpfront costs
Can get lower interest ratesYou might have to pay origination fees

When is the best time to consolidate your debts?

There are several factors to consider. First, if you have a large amount of debt and your credit score is high enough to qualify. Secondly, if you make several minimum monthly payments on multiple debts each month, debt consolidation may be a good option. Lastly, consolidating your debt may be another good reason if you have a cash flow issue.

READ MORE: How to consolidate installment loan debt

When is debt consolidation a good idea?

For some, consolidating debts can be life-changing, while it simply isn’t practical for others. Here are some general guidelines to help determine if it’s a good idea for you.

Debt consolidation can be a good idea if:

  • You’re overwhelmed by multiple monthly bills and can’t pay them off
  • You’ve taken inventory of all your existing debt
  • Your total debt isn’t more than 40% of your gross income
  • Your credit score is high enough to secure a low-interest debt consolidation loan
  • You have done all your research and understand what you’re getting into

Debt consolidation is not a good idea if:

  • Your credit rating is too low for you to secure a low-interest loan
  • You are consolidating unsecured debt with a secured loan
  • You are spending more than you earn or if you still haven’t solved your spending problems. Before taking any action, you need to reassess your financial situation to make sure you can handle the new loan.
  • Your debt load is too small; in that case, applying for debt consolidation often doesn’t make sense.

Does debt consolidation hurt your credit?

Debt consolidation loans can hurt your credit, but it’s only temporary. Your score will improve over the long run. Once approved for the loan, the lender will do a hard pull on your scores before closing. This is where your credit will take a hit. But once you have paid off all your high-interest loans, your credit scores can improve in the long run.

READ MORE: Five simple ways to consolidation credit card debt

How debt consolidation can affect your credit

Depending on a few factors, debt consolidation can either hurt or help your credit. By opening another new account from the debt consolidation, the average age of all your accounts will be lowered and can negatively impact your credit history.

The credit inquiry from the hard pull can also lower your score, and higher credit utilization also reduces your score.

But it could also raise your score if the loan lowers your credits utilization and you make all your one-time payments on time, making this positive for your payment history.

A hard inquiry is performed

A hard pull could lower your credit score by 10 points. Hard inquiries will only affect your credit score for one year.

The credit utilization ratio may decrease

Have a large credit card balance? You may also have a high credit utilization ratio. 

You can calculate this by dividing your current card balance by your total credit limit. You will want to keep your credit debt ratio as low as possible.

But if you use a loan to pay off that balance, the utilization percentage drops, and your credit score will boost. The credit utilization ratio accounts for 30% of your credit score.

Closed accounts may hurt your score

It may seem counterintuitive, but paying off accounts and closing them can hurt your credit score. The average age of your credit accounts makes up 15% of your score. The higher the average age of your accounts, the better your score. Your credit history’s average age decreases when you open a new account. If you close old or inactive accounts after consolidating, it will further lower the average age of your accounts.

READ MORE: How does debt consolidation affect your credit score

How to check your credit reports and credit score for free

You can check your credit scores for free at:

  • By Phone: Call 1-877-322-8228. For TTY service, call 711 and ask the relay operator for 1-800-821-7232

Other options for debt relief

Debt settlement: Debt settlement programs typically are offered by for-profit companies and involve the company negotiating with your creditors to allow you to pay a “settlement” to resolve your debt. The settlement is another word for a lump sum that’s less than the total amount you owe.

Debt Management Plan: Debt Management Plans are similar to debt consolidation companies, except a nonprofit credit counseling agency usually runs them. The credit counselor will help you better understand your financial situation and help you establish a payment plan. The cost usually ranges from $25 to $55 a month.

Bankruptcy: Chapter 7 bankruptcy is the simplest and most common form of bankruptcy. In Chapter 7, if the debtor has assets not protected by an exemption, a court-appointed trustee may sell the assets and distribute the net proceeds to creditors according to the priorities established in the Code. Chapter 7 is known as liquidation bankruptcy and can erase many types of consumer debt, including credit card debt and medical bills. Chapter 13 is the wage-earner’s plan. Chapter 13 allows individuals to pay off lenders with a 3-5-year monthly payment plan depending on their steady income. In Chapter 13 bankruptcy, you must devote your disposable income to your repayment plan. In Chapter 13, you can protect a debtor’s home from foreclosure.

READ MORE: Debt consolidation for the unemployed

The bottom line

Being buried by a mountain of debt doesn’t have to feel hopeless. There are many avenues you can explore to try to get your debt under control.

But it is important to note that you will need to have fiscal responsibility, and this includes changing your spending habits, or you will end up in the same predicament or worse.


What are loan prepayment penalties?

A prepayment penalty is a fee that some lenders charge if you pay off all or part of your loan early. If you have a prepayment penalty, you would have agreed to this when you closed your loan. Not all loans have a prepayment penalty.

What is the difference between debt consolidation and debt settlement?

In debt settlement, you deal with a company. They make you stop paying the creditors as they negotiate your interest rate and pay your creditors on your behalf. You pay 50%-80% of the balance, and you are tagged with late payments that get reported to the three major credit reporting companies. Your credit will take a hit, and the derogatory remarks will remain on your credit for seven years.
Debt consolidation is the rolling in of multiple debts into a single payment via a personal loan. It saves you time and money, and your credit scores may take a minor hit.

What credit score is needed for debt consolidation?

To qualify for a debt consolidation loan, you’ll have to meet the lender’s minimum requirement. The credit scores are often in the mid-600 range, although some bad-credit lenders may accept scores as low as 580. Many banks offer free tools that allow you to check and monitor your credit score.

About The Author

Scroll to Top