Debt Consolidation Loans vs. Personal Loans: What’s the Difference?
For those consolidating debt, a loan can be a good way to save money while also creating a predictable repayment schedule. These loans can be used to pay off high-interest credit cards and reduce the number of payments you need to make each month.
But do you need a debt consolidation loan or a personal loan?
That’s something of a trick question because all debt consolidation loans are personal loans. They are specifically offered for those who are trying to get out of debt. Other personal loans may be intended for different purposes, such as the purchase of a car or home renovations.
If you’re ready to get out of debt but aren’t sure which loan is right for you, learn how these loans are the same — and different.
Similarities and Differences Between Debt Consolidation and Personal Loans
For both personal loans and debt consolidation loans, borrowers receive funds that must be paid back over a certain number of years. In both cases, loan money can be used to pay off high-interest debts, which can decrease monthly payments and, potentially, total interest charges.
The loans have some key similarities and differences:
- Both will affect your credit in the same way.
- Both are unsecured.
- Credit score requirements may be different.
- Funds may be distributed differently.
Both will affect your credit in the same way
Regardless of whether it’s marketed as a personal loan or a debt consolidation loan, any money you borrow will have the same effect on your credit score.
The application process for most loans will result in a hard inquiry on your credit file, which could drop your score by a few points temporarily. Once the loan has been approved, the lender will report your payments to credit reporting agencies. Timely payments will help boost your credit score while late or missed payments could negatively affect your creditworthiness.
Your credit score will also benefit from either type of loan so long as you are paying down your total debt. That means if you are consolidating credit card debt, it’s important not to continue charging purchases to your credit cards. Otherwise, your credit score could suffer.
Both are unsecured
Both personal loans and debt consolidation loans are unsecured, which means lenders don’t require collateral as a condition of approval.
Collateral is an asset, such as a house or car, that an applicant offers to a lender to secure the loan. If the person stops making payments, the lender has the right to take the collateral.
With personal loans and debt consolidation loans, collateral typically isn’t needed. That makes these loans more accessible to borrowers.
Loan terms may be different
As mentioned before, all debt consolidation loans are personal loans. However, not all personal loans can be used for debt consolidation. Some lenders may want to know what you plan to do with the money and only lend to borrowers who are using cash for approved purposes such as buying a car.
Credit score requirements and interest rates can also differ by lender. There are no hard and fast rules about what credit score is needed to take out a loan, and options are available for those with everything from bad to excellent credit.
You may find that lenders who specialize in consolidating debt are more open to approving applications from those with lower credit scores. But be aware that they may also have higher interest rates than what is charged for personal loans extended to those with excellent credit.
Funds may be distributed differently
With a personal loan, money will be deposited directly into your bank account within days of approval. In some cases, a check may be sent through the mail instead.
With debt consolidation loans, you may be able to receive the money directly or, with certain lenders, request that funds be sent directly to the accounts you plan to pay off. This option eliminates the need for you to handle the money and make payments. It also removes the temptation to spend the loan funds on something else.
Which Loan Is Right for Me?
To find the right loan, you’ll need to consider both your personal and financial situation. Before shopping for a loan, answer the following questions:
- How much do I need to borrow?
- What is my credit score?
- Will all the loan money be used for consolidating debt, or do I need cash for another purpose as well?
- Do I want the lender to pay off bills directly?
When to get a debt consolidation loan
A debt consolidation loan may be right for you if you have a low credit score and a significant amount of debt to pay off. This is also a good option for anyone who isn’t sure they have the time or self-discipline to quickly pay off debts after the loan money arrives. In that case, look for a debt consolidation lender who will send money directly to your other creditors.
When to get a personal loan
A personal loan may be right for you if you have good credit and want the lowest interest rate possible. A personal loan is also a good choice for anyone who has multiple financial needs. For instance, maybe you want to pay off a couple of credit cards but also need cash for car or home repairs. A personal loan could provide money to cross both items off your to-do list.
Either way, make sure the terms of the loan make sense to you. Confirm that the interest rate on the loan will be lower than what you are currently paying on your existing debt. Also, check to see if the interest rate is fixed or variable — which means it can change over time. Finally, confirm you can comfortably make the monthly payment before committing to the loan.
With a little research, you may be able to cut your debt payments and eliminate the need to juggle multiple bills each month. Get started by comparing the best personal loans here.
