How Do You Qualify for a Debt Consolidation Loan? (2024 Guide) (2024)

Every borrower’s situation is different, but the steps to evaluate whether a debt consolidation loan is right for you and to apply for one are largely the same. Here’s what to do if you’re considering this financial move.

Evaluate Your Debt Situation

Whether debt consolidation is the best move for you depends on the type of debt you have, your interest rates and your overall financial health. Typically, debt consolidation loans are used for unsecured debts, like student loans and credit cards. Because there are fees associated with creating a new loan, consolidation makes the most sense when there are large balances that would take years to repay; otherwise, you could just pay off your creditors in a short time without any extra charges.

Ideally, a debt consolidation loan should reduce your overall interest rate. For example, if you have student loans at 6% interest and a car loan at 5% interest, debt consolidation is unlikely to make sense because the average debt consolidation loan is between 6% and 36%, which is most likely more than you’re paying now.

However, for someone who is in thousands of dollars of credit card debt at 29% interest, debt consolidation is likely worth pursuing.

Check Your Credit Score

As with any other loan, your credit score factors into the terms your lender will offer on a debt consolidation loan. Because this is a type of unsecured loan (meaning there is no collateral like a house or car to back the loan), lenders rely heavily on your credit score and payment history to gauge whether you can repay your loan.

The minimum credit score needed to secure a debt consolidation loan ranges from 580 to the mid-600s, depending on the lender. The best terms and rates go to borrowers with scores that are around 700 or higher.

To get a free copy of your credit report that details all the items that affect your score, visit this website. You can receive a copy of your score annually, and doing so does not affect your score. Making on-time payments on your existing debt, reducing your credit card balances and disputing any errors on your credit report will help you improve your credit health.

Calculate Your Debt-to-Income Ratio

A debt consolidation lender will want to make sure you haven’t taken on more debt than you can handle, so they will ask for information regarding all your income and debts. If your debt is too high relative to your income, you may be better served by credit counseling or debt settlement (more on these below).

To calculate your debt-to-income (DTI) ratio, add up the monthly payment amounts on all of your debts. Then, divide that number by your gross monthly income (before taxes and deductions). Next, multiply by 100 to get the percentage. For example, if you have a $750 student loan payment, a $250 personal loan payment and $500 in credit card payments, your total debt payments would be $1,500 per month. If your income is $4,000 per month, your debt-to-income ratio would be 37.5% ($1,500 / $4,000 = 0.375 x 100 = 37.5%).

Lenders typically want your debt-to-income ratio to stay at 35%-45% or less to approve you for a debt consolidation loan.

Gather Necessary Documentation

To qualify for a debt consolidation loan, calculate your debt-to-income ratio and evaluate your financial situation, you’ll need to gather quite a few documents — both for your own knowledge and for the benefit of the lender once you apply for a loan.

You’ll need basic proof of identification, like a driver’s license and Social Security card, as well as documents to prove your income, like pay stubs, bank statements and tax returns. You’ll also want to gather the latest statements from your loans and credit card accounts. Make sure they have critical information on them, like the interest rate and remaining principal. Organizing these documents can help expedite the application process.

Research Lenders and Loan Requirements

Each lender has its own procedures, requirements, terms and interest rates, so it’s to your benefit to shop around to get the best deal. Research the various lenders and their eligibility criteria to find which one will suit your needs.

Determining your top priorities for your debt consolidation will help you narrow down your search. For instance, if you’re looking to reduce the interest you pay overall, a low APR will be the most important factor. If you’re burdened by the amount you pay each month, a lender that offers a manageable low payment may be the best choice, even if you’ll pay more interest in the long run.

Improve Your Qualifications

Two main ways to make yourself a more attractive candidate for a debt consolidation loan are to pay down your debts and increase your credit score.

Reducing your debt balances will reduce your debt-to-income ratio and can be achieved by increasing your monthly debt payments, reducing your monthly discretionary spending and increasing your income.

If you need to boost your credit score to qualify for a debt consolidation loan, here are a few tips to quickly raise your score:

• Contest any errors on your credit report
• Strategically pay on your credit cards to get each below 30% credit utilization (or as close to it as possible)
• Become an authorized user on the account of a friend or family member with a good credit score
• Ask your lender to raise your credit limit for revolving accounts (like credit cards)

With your credit score and DTI optimized, you’re ready to apply for a debt consolidation loan. Here are the basic steps for doing so.

Prequalify for Loans

When shopping for terms and rates from different lenders, you can get a good idea of whether you’d be approved by becoming pre-qualified. There are many free online tools and debt consolidation calculators that allow you to type in your financial information (credit score, debt balances, interest rates, etc.) and see what interest rate and terms you may qualify for. The results you get from prequalification aren’t a guarantee until you formally apply for and accept a loan, but it will give you a good idea about what to expect and which lender to choose.

You can talk to multiple lenders without any fear of what it will do to your credit score; prequalification typically results in a “soft pull” on your credit, which does not harm your score.

Review Loan Offers

After getting prequalified, you can compare the loan proposals, focusing on these areas:

• Interest rates
• Terms and conditions
• Total cost of the loan
• Monthly payment
• Closing cost fees
• Early repayment penalties
• Origination fees (fees lenders charge to cover the costs of underwriting the loan)

Ideally, you’ll want to pay the least amount of interest over the life of the loan, but that may not be your only consideration. If you want to get out of debt quickly, you may opt for a shorter loan term. And if you’re already struggling to pay your debts, a low monthly payment may be an important feature to look for. Choose the loan that best meets your financial goals.

Complete the Loan Application

Once you’ve chosen the best lender for your situation, it’s time to apply. A successful loan application includes the submission of all the required documents including proof of identity, recent information on your debt balances and income and any other information required from the lender.

Be sure you fill out all the paperwork thoroughly and accurately, as your lender will go through the information with a fine-toothed comb during underwriting, and any discrepancies will likely delay the approval process. Be ready to respond quickly to any additional questions or requests from the lender.

At this stage, your lender will run a “hard pull” on your credit, which will likely drop your credit score by a few points. However, the dip will probably be temporary.

Accept the Loan and Repayment Terms

When you receive your loan offer, double-check the repayment schedule, APR, fees and other terms or obligations of the loan. Ask questions about anything that isn’t clear or that you don’t understand. When you’re satisfied with the terms of the loan, sign the offer and begin your repayments.

No financial tool is perfect, and debt consolidation loans are no exception. Here are a few of the benefits and drawbacks of merging your debts in this manner.

Pros of Debt Consolidation Loans

• One payment to worry about: The simplicity of making one payment instead of several is a compelling reason to consider consolidating your debts.
• A lower interest rate — possibly: If your debt happens to be credit card, payday loans or another high-interest type debt, the APR on your consolidation loan will likely be lower than what you’re currently paying.
• Faster debt repayment: Most lenders make loan terms between 12 and 60 months; choosing a loan with a short term may provide an extra push to get rid of debt quickly.
• Raise your credit score: Paying off multiple unsecured or revolving accounts (read credit cards) may increase your credit score.

Cons of Debt Consolidation Loans

• Only available to those with decent credit: Debt consolidation is, ironically, only a possibility for those who have a high enough credit score and a low enough DTI.
• It won’t solve underlying financial flaws: You’ll need to change your income, spending or both to stay out of debt once you pay it off.
• Fees: Those loans don’t underwrite themselves, so the lender charges loan origination and other fees to cover their costs of administering the loans — charges you might not have to pay if you paid your creditors on your own.
• A higher interest rate — possibly: If your debts carry low interest rates (such as a car note, student loans or medical debt), the interest rate on a debt consolidation loan may be higher than what you’re already paying.

Debt consolidation loans are best for borrowers with good credit and a low DTI who want to merge several high-interest debts into a single payment. Their strong financial indicators make them likely to find interest rates that are lower than their creditors currently offer, which makes consolidating both cheaper and simpler.

However, a debt consolidation loan isn’t the only way to pay off debts quickly or combine them into one payment. Some people use balance transfer credit cards, HELOCs or home equity loans in much the same manner — they take out one unsecured debt account to pay off the others.

For those who are deeply in debt and feel crushed by the number and/or volume of payments, nonprofit credit counseling may be a better avenue. Credit counselors provide education and administer debt repayment plans in which borrowers pay one payment each month to the counseling agency, which in turn pays the creditors.

Debt settlement companies (those who negotiate with lenders on your behalf to accept less than the amount owed to settle the debt) and bankruptcy are generally considered final resort options, as these actions can damage your credit for a long time.

Certain borrowers that have a lot of high-interest debts can benefit from a single, potentially more affordable payment offered by debt consolidation loans. This financial management tool can make paying off debts simpler, cheaper and faster.

While debt consolidation can be effective in some scenarios, it doesn’t make sense in every situation. Borrowers need good credit and a low DTI to qualify for low enough interest rates to make debt consolidation worthwhile.

It’s also important to note that debt consolidation is not a cure-all; it does not solve the problem of taking on unwieldy amounts of debt. Borrowers must adjust their income and/or spending to make true financial progress. However, debt consolidation can provide a much-needed reset to one’s finances, simplifying the task of eliminating the burden of debt.