Debt Consolidation Loan

Full definition

A debt consolidation loan is a type of personal loan whose purpose is to pay off multiple existing debts, leaving the borrower with a single loan to repay. The financial benefit requires that the new loan's APR be meaningfully lower than the weighted average APR of the debts being consolidated. Math example: $15,000 in credit card debt at 24% APR (minimum payments only = decades of repayment, thousands in interest). Consolidation loan at 14% APR, 4-year term: $388/month, total interest = $3,624. Same $15,000 at 24% APR paid over 4 years: ~$438/month, total interest = $6,024. Savings: $2,400 in interest plus psychological simplicity. When debt consolidation works: Borrower qualifies for a rate significantly lower than existing debt rates. Borrower will not run up the credit cards again after consolidating (this is the most common failure mode - cards are paid off but then re-accumulated). Monthly consolidated payment is manageable within the budget. When consolidation fails or backfires: Rate improvement is marginal (less than 3-4 percentage points). Borrower uses the freed-up credit card capacity to accumulate new debt. Loan term is extended so far that total interest paid exceeds the original debt. Origination fees offset the interest savings. Credit score impact: Hard inquiry at application: -5 to -10 points temporarily. New account lowers average age of accounts: small negative short-term. Reduced credit utilization (cards paid off): positive effect if cards are kept open but not charged up. Net effect: credit score often improves after 6-12 months of on-time payments on the consolidation loan. Alternatives: Balance transfer credit card (0% intro APR for 15-21 months, 3%-5% transfer fee) for smaller amounts repayable within the promo window. Home equity (HELOC or cash-out refi) for larger debt amounts with home equity available - lower rates but secured by the home.

• Debt-to-income ratio (DTI)
• Credit utilisation