A debt consolidation loan works by giving the borrower a lump sum of money to pay off multiple existing debts. Instead of owing several smaller debts and having to make monthly payments for each, the borrower is only responsible for one larger payment on the debt consolidation loan. Assuming the consolidation loan has a lower interest rate than the debts it was used to pay off (and that lower rate isn’t offset by expensive fees), the borrower can pay off what they owe sooner and at a lower overall cost.
A debt consolidation loan usually lasts anywhere from 12 to 60 months. But depending on the lender, it could be even longer. Popular lenders offer anywhere from $1,000 to $100,000 in funding. Interest rates on debt consolidation loans (which are usually just general personal loans) can range from around 6% to 36%.
Ideally, a borrower should only take out a debt consolidation loan if they have pre-qualified for a lower rate than what their current debts charge. Similarly, it’s best to borrow as much money as it takes to pay off the debts, but not so much that the resulting monthly payments are unaffordable.
How a debt consolidation loan works:
- The borrower submits an application.
- The lender evaluates the application and decides whether to issue a loan.
- Assuming the loan gets approved, the lender disburses the funds to the borrower.
- The borrower uses the funds to pay off their existing debts.
- Each month, the borrower makes the required payment to the lender.
A debt consolidation loan doesn’t work much differently from any other personal loan. The only real defining characteristic is that the borrower uses the initial lump sum from the loan to pay off multiple debts. Debt consolidation loans can be a great resource for borrowers if they can take advantage of a low interest rate.
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