Personal Loans to Consolidate Debt

Introduction

Answers to The Most Frequently Asked Questions

Although personal loans have been around for centuries, the convenience of credit cards has largely filled the need for consumers to obtain short-term, on-demand loans. Instead of applying for a personal loan when you have an unexpected expense personal savings will not cover, you can simply charge the purchase and pay it off over time with a credit card.

When there is not enough available credit on existing credit card accounts, consumers are once again turning to personal loans to access additional lines of credit at lower interest rates with more favorable terms than those found on most credit card loans.

The combination of maxed-out credit cards and expanded, easy access through online lending channels have increased the popularity of personal loans. According to Experian, personal loans have seen an 11% increase from 2018 to 2019.

The Fintech industry made personal loans easier and cheaper to obtain with the online process lowering loan origination costs and reducing the time between application and funding. Consumers now use personal loans to pay for weddings, vacations, medical expenses not covered by insurance, to consolidate high-interest credit card debt, and pay for business start-up expenses or home renovations.

Even though personal loans are not new, the expanded access to personal loans online and the increased number of personal loan lenders in the marketplace have increased both the popularity and competitiveness of personal loan products available to consumers today.

Below, we have compiled a list of the top questions regarding how personal loans work and what factors you should consider before taking out a personal loan.

Key Takeaways
  • Personal loans can bridge a shortfall between income and expenses, allowing you to pay over time with a set interest rate and loan term.
  • Consolidating high-interest credit card debt is one of the top reasons consumers take out a personal loan.
  • Online lenders have increased the demand for personal loans by making them available to more consumers and expediting the loan application and document management process.
  • You must qualify for a personal loan through standard underwriting practices that consider your income, credit score, and other underwriting criteria which may vary by lender.
  • In most cases, personal loans do not require collateral, but those that do, usually come with lower rates and better terms.
  • You can qualify for a personal loan without perfect credit.

What is a Personal Loan?

To apply for a personal loan, you request a specific amount of money you will repay over a set term at a fixed interest rate. The lender underwrites the loan, performing a credit check, verifying your salary, and comparing income with your current debt levels. The loan term and interest rate will depend on the strength of these criteria when submitting your loan application. Once approved, you could receive funding the same day, but usually within 72 hours of approval if applying online.

A personal loan provides cash for a variety of needs and usually does not come with restrictions on how the funds may be used. Unlike a home or auto loan, it is unnecessary to disclose how you plan to spend the money. In some cases, the lender will deduct loan fees from the proceeds, allowing you to finance any origination or loan closing costs.

How Many Personal Loans Are There in the US Today?

As of the second quarter of 2019, there were 38.4 million outstanding personal loans in the US. Balances rose to $305 billion from $273.3 billion in the prior year, a 12% increase in personal loan balances year-over-year. While personal loans account for a small percentage of overall lending, this category of lending is experiencing faster growth than all other lending categories, including mortgages, auto loans, and credit card loans.

In addition to a growth in the number of loans originated, consumers are also borrowing more. Loans balances greater than $30,000 increased by 15% over the last five years, and loans between $20,000 and $25,000 grew more than 10% over the same period. As of Q2 2019, the average loan payment had risen to $360/month.

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How are Personal Loans Different from Credit Card Loans?

The primary difference between a personal loan and a credit card loan is the structure of the debt. A personal loan begins with a single distribution, repaid over a set time with a fixed interest rate. Credit card issuers offer an open-ended line of credit, which you can borrow against, repay, and borrow against again without requalifying for new debt. Credit card companies charge a variable interest rate, usually tied to the US Prime Lending Rate, and require a minimum monthly payment that barely covers the interest charges in many cases.

Another distinct difference between personal loans and credit card loans is how interest is calculated and compounded. With a personal loan, the interest rate is fixed for the term of the loan, and the interest is calculated using a simple interest calculation where 1/12th of the Annual Percentage Rate (APR) is applied to the balance at the closing of the billing statement each month. Credit card loans on the other hand apply and compound interest daily using the Daily Periodic Interest Rate method which is 1/365th of the Variable Annual Percentage Rate. The effect of daily compounding interest is what makes credit card loans so expensive and so hard to pay off when only making minimum payments each month.

Lenders rely solely on your credit score and stated income to qualify for a new credit card account. Once approved, many companies offer low introductory rates to encourage you to use the card. You can transfer an existing balance with a rate as low as 0% for an introductory period of six months to two years. Credit card balance transfers are best used for transferring small amounts that you can pay off before the promotional period ends.

Personal loan lenders, on the other hand, can grant larger loans with a longer repayment term. The underwriting process generally includes a credit check from one of three consumer reporting agencies and income verification. Larger loan amounts could require more underwriting procedures, such as verifying assets or reviewing your bank statements or tax returns. Personal loans are best used for larger financial purchases or consolidating existing credit card debt into a single payment with a set repayment period.

How Much Can I Borrow with a Personal Loan?

Lenders typically offer loans online up to $40,000, but some conventional lenders may offer loans up to $100,000 with supporting credit and income criteria. The individual lender, type of lender, your credit history, and your income in relation to your current debt levels will determine your maximum loan amount.

Short-term loans of $1,000 or less, offered through Payday lenders, carry exorbitant fees and interest rates as high as 400% or more. These types of loans are typically paid back in a few weeks or a few months and can roll over with additional fees and escalating interest rates if not prepaid in full when due. These types of loans are strictly regulated and even banned in many states due to their predatory interest rates and terms.

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However, longer-term loans offered through conventional or online lenders grant higher loan amounts, much lower interest rates, and more favorable terms. If you opt for a short-term loan to cover unexpected expenses, be sure you carefully read and understand the loan documents before accepting the loan. Be certain you can meet all the loan terms and that the reason for the loan is consistent with your short-term financial goals.

What is the Typical Interest Rate for a Personal Loan?

Interest rates for personal loans can range from 3.0% to 35.99%. Lenders use multiple factors to determine the interest rate offered, including credit score, income calculation, debt to income ratio, collateral, and the term of the loan. The stronger your financial profile, the lower the interest rate, and the better terms you will receive. Many states have implemented laws that cap the interest rates lenders can charge consumers for personal loans at 36%. Loan offered at rates above this amount are generally considered high-interest, short-term loans, or, sometimes referred to as “Pay Day Loans” and are regulated differently from personal loans with an annual APR of less than 36%.

What is the Typical Term for a Personal Loan?

Most personal loans come with an average repayment term between 24 and 60 months. However, some lenders offer terms that can extend up to seven years. Loans backed by collateral could last as long as 30 years. Online lenders typically offer loans up to $40,000 with competitive interest rates and terms based on the strength of your credit history. Conventional lenders may offer more flexibility with loan amounts and loan terms for borrowers with excellent credit and/or a prior banking relationship much higher than is typically available with most online lenders. If you have excellent credit and need a larger loan or a longer loan term, consider applying for a loan with a conventional bank or credit union to secure a loan with the best possible combination of the loan amount, interest rates, and repayment options.

What are the Requirements to Qualify for a Personal Loan?

You can obtain a personal loan with varying credit quality and documented source of income. Today, online lenders offer loans to people with varying credit scores and income. If you have good credit, steady income, and a low enough debt to income ratio, you will find lenders are more likely to offer larger loan amounts, lower interest rates, and longer loan terms. Lenders set the interest rate and loan terms based on risk. Higher risk loans generally come with higher interest rates and shorter loan terms. If you are using a personal loan to pay off your high-interest credit cards, you may find that a slightly higher than normal personal loan rate will still yield some savings each month due to the way interest compounds daily on credit card loans.

Before accepting any loan, be sure to read and understand all the loan disclosures and carefully read all loan documents. These disclosures will clearly explain the costs associated with the loan you are considering and will itemize the costs such as the loan application fees, loan origination fees or points charged, and how much you will pay in total interest over the term of the loan. If you intend to use the loan to pay off your credit cards, be sure to compare the total loan cost to what you will pay over the same term of a credit card loan to see if the savings warrant taking a personal loan to pay off your credit card accounts.

Where Can I Apply for a Personal Loan?

The availability of personal loans has never been greater than it is today. Traditional lenders and FinTech (online) lenders offer loans to people with varying credit incomes. Banks, local credit unions, and private lenders typically make personal loan offers to existing customers with favorable rates, terms, and higher loan amounts. You can also apply to an online FinTech lender or a peer-to-peer lender and receive loan funds in as little as 24 hours.

The growth of online lenders has skyrocketed in the past 5 years with online lenders now making up over 50% of all personal loans issued in the US today. These lenders offer a wide range of rates and terms, with some specializing in consumers with imperfect credit and others only lending to customers with excellent credit.

What Are the Differences Between Bank Lenders and Online Lenders?

Traditional banks tend to use conventional underwriting practices, limiting personal loans to consumers with excellent credit and a personal or business banking history with the bank or credit union.

Online lenders tend to service a broader range of customers and offer lower rates and fees than traditional lenders. FinTech lenders have lower expenses because they do not incur the cost of maintaining physical branches because the application and funding process is 100% and fully automated.

In most cases, you will not even speak with a representative on the telephone. You can apply online, upload required documents, and receive funding via direct deposit, allowing you to receive money much faster than traditional banks and credit unions.

What is a Peer-to-Peer Personal Loan, and How Do They Work?

Peer-to-peer lending is the newest lending option available to consumers. Peer-to-peer lenders connect individual investors with borrowers through an online lending platform. Most loans are personal loans funded by multiple private investors through a crowdsourcing model. You can receive funding within a few days, provided investors choose to invest in your loan.

Once funded, you make your monthly loan payment through the platform, and the company distributes payments to the participating investors. The company makes money through fees charged. Origination fees range from 1 to 6%, and interest rates are set based on your risk profile which includes minimum credit score requirements, debt-to-income ratio, and verifiable income.

Will Applying for a Personal Loan Hurt My Credit Score?

The short answer is not usually. Credit bureau scoring companies use five primary factors when tabulating your credit score. These include repayment history, credit utilization ratio (the debt-to-line-of-credit ratio), the mix of loans and credit lines, length of credit history, and new credit inquiries. Inquiries made to creditors for new lines of credit make up just 10% of your overall credit score calculation.

The credit bureaus report these new credit applications (hard credit pulls) for only two years (24 months), as opposed to seven years (84 months) for payment activity or other negative items such as late payments or some bankruptcies. Therefore, these types of credit bureau inquiries have the least impact and affect your score for a shorter period than any other factors that make up your credit score.

Credit scoring companies consider all applications of the same loan type (i.e., personal loans) within a given timeframe as a single event, lessening the impact of price shopping on your credit score. Because of this practice, you should apply for any loans of the same type within a 14-day timeframe to avoid a negative impact on your credit score.

Do I Need Collateral to Qualify for a Personal Loan?

No, but in some cases, pledging collateral may improve the likelihood of approval, lower your interest rate, and increase the amount of loan you may qualify for. Most personal loans do not require any type of collateral. However, pledging collateral to lenders to secure a loan reduces the risk to the lender. Any time a lender has less risk exposure, they can offer better interest rates, loan terms, and, depending on the value of the collateral pledged, higher loan amounts.

However, consolidating your high-interest credit card debt through a home loan converts unsecured debt to secured debt collateralized by your home, which could put your home in jeopardy, should you struggle to keep up with payments. Loans such a Home Equity Lines of Credit or taking a loan in the form of a cash-out refinance to withdraw accrued equity in your home can take 30 to 60 days to close and come with high costs because the lender must approve you and the collateral and perform other services like title searches, home appraisals and order a survey of your property. Other fees may include a home inspection and real estate closing costs, attorney representation fees, and certain state, county, and local taxes and recording fees based on your state of residence or location of the property

Personal loans without collateral rely on your credit history and income, allowing you to receive funds within a few days. The interest rate and loan term offered will reflect the strength of your credit score and income because the lender cannot repossess the collateral if you cannot make payments on the debt.

Can I Get a Personal Loan if I Have Bad Credit?

Yes. Some lenders specialize in working with consumers who have average to poor credit, however, you can expect to receive a higher rate of interest and higher loan fees. If you only qualify for an interest rate in the high 20% range, you may not save much by consolidating your high-interest credit cards with a debt consolidation loan.

Before accepting any loan, be sure to compare the interest rate and loan terms with your current credit card bills to determine if the new loan will help you pay off debt faster for less money. If not, you should explore other debt relief options that are best suited for your circumstances. Most debt relief providers offer free telephone consultations where they can review your current credit card accounts and make comparisons to other options designed to lower your monthly payments and get you out of debt years sooner.

Is It a Good Idea to Consolidate Credit Card Debt with a Personal Loan?

If you have a higher than average credit score, and enough income to support an additional loan, you could find better loan terms than you currently have on your credit card accounts. A personal loan could allow you to pay off debt faster and save money through a lower interest rate simple compound interest.

However, a personal loan does not pay off debt. It only transfers balances to a new loan. In most cases, you are not required to close existing credit card accounts, creating the temptation to add new debt by making additional charges. Charging new purchases could leave you in a worse financial position than you were before getting a personal loan. Running up new debt balances will also hurt your credit score, making it harder to qualify for new credit lines or other forms of debt relief in the future.

How Much Can I Save Paying Off Credit Card Debt with a Personal Loan?

Your level of savings will depend on your current credit card interest rates and the new personal loan rate and terms.

Paying the minimum amount each month on credit card debt could take 30 years or more and you could end up paying over three times the amount you are charged with daily compound interest, penalties, and fees applied over time even if you stop using your credit cards today. A personal loan will provide a fixed term and interest rate, and a steady, predictable monthly payment, making it easier to budget and pay down debt faster.

Does Paying Off Debt with a Personal Loan Hurt My Credit?

It depends. Credit scoring companies consider credit utilization as 30% of your score. This ratio measures your revolving credit and loan balances against your current credit limits. Maxed out credit cards raise your credit utilization, damaging your credit score.

Converging lines of credit (i.e., credit card debt) into a single loan could help your score, provided you are not adding new debt to your now new open lines of credit.

If I Can’t Qualify for a Personal Loan, What Other Debt Relief Options Should I Consider?

Personal loans are not always the best alternative to lowering your monthly debt payments or shortening the time to pay off your debt, either because you cannot qualify or cannot get terms attractive enough to warrant accepting the loan. In this case, it is time to explore other available debt relief options.

If you have some income, a reasonable amount of debt, and you can pay off all your credit card debt in five years or less with some interest, you may consider seeking the services of a non-profit credit counseling agency. Many credit card issuers will lower interest rates, but still require full repayment in five years or less to qualify. You will have to undergo budgeting and financial management education courses and demonstrate you can make the required payments through financial analysis.

However, if you are unable to make all the payments required in a debt management plan administered by the credit counseling agency, you may find yourself worse off, as your credit card companies may reimpose interest retroactively and add back any late fees or penalties to your unpaid balance.

If you currently struggle to make even the monthly minimum payments or are burdened with a high amount of credit card debt, you may consider seeking the services of a professional debt settlement company to negotiate with your creditors on your behalf. You save money each month by reducing the amount you pay toward your credit card debt and redirecting those funds into a special purpose savings account that is used to settle accounts with your creditors.

As your savings balance grows, the debt settlement company will negotiate a payoff of your debt for less than you currently owe and use the funds in your savings account to pay your creditors. Settling your credit card debt through a professional debt negotiation company provides debt relief by immediately lowering your monthly payments and allowing you to settle the enrolled debt for less than the full balance owed, giving you both short and long-term financial relief.

If you face a financial hardship that prevents you from repaying your debts in full, you could benefit from debt settlement. You can choose which accounts to enroll in the program and keep those you may need for an emergency or business travel, giving you greater flexibility than other types of debt relief options. It typically takes between two to four years to complete a debt settlement program and most people see a 25% to 35% reduction in their total enrolled debts after all fees.

FAQs
  • How Are Personal Loans Different from Debt Consolidation Loans?

    There is little distinction between a personal loan or a debt consolidation loan. Most personal loans do not come with restrictions on how the funds can be used. However, some traditional lenders may make loans secured by an asset, such as your home, for the purpose of paying off certain debts. In this instance, the lender may require that you sign an agreement to have the debt paid off from the proceeds of the loan, and then have the account closed so that you cannot incur further debt.

  • Does Consolidating Debt Hurt Your Credit Score?

    In some cases, you may see a slight drop in your credit score. Consolidating debt is not the same as paying off debt, even if you pay off and close other accounts. Since your credit score is impacted by new credit inquiries, the age of your credit history, and your credit utilization ratio, all these factors may be impacted by applying for a new loan, closing an account, or reducing your available credit or average age of your credit history by closing a paid off account.

  • What Credit Score Do You Need for a Personal Loan?

    Personal loans are approved based on several factors including your credit score, verifiable income, debt to income ratio other factors like payment history and even your prior personal or business banking relationship with the lender. All these factors help to determine the risk for the lender. Your FICO credit score ranges from 300 to 850. Lenders typically offer the best rates and terms to people with a 720 score or higher, but most require borrowers to have at least a 660 FICO score or above. Some high-risk lenders may offer loans to people with a score below 660, but those loans typically come with higher interest rates, shorter terms, and much higher fees.