Sara Routhier, Managing Editor and Outreach Director, has professional experience as an educator, SEO specialist, and content marketer. She has over five years of experience in the insurance industry. As a researcher, data nerd, writer, and editor she strives to curate educational, enlightening articles that provide you with the must-know facts and best-kept secrets within the overwhelming world o...

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Joel Ohman is the CEO of a private equity-backed digital media company. He is a CERTIFIED FINANCIAL PLANNER™, author, angel investor, and serial entrepreneur who loves creating new things, whether books or businesses. He has also previously served as the founder and resident CFP® of a national insurance agency, Real Time Health Quotes. He also has an MBA from the University of South Florida. ...

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Reviewed by Joel Ohman
Founder, CFP® Joel Ohman

UPDATED: Dec 1, 2012

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A consolidation loan is a form of financing used to repay multiple debts. Instead of paying off several loans throughout the month, consumers can use a consolidation loan to merge all of their existing debt into one payment. Even though multiple debts are combined into one, the monthly bill is usually structured to be more than manageable.

Contrary to popular belief, a personal consolidation loan does not reduce the amount of debt owed, but it does make paying bills easier. Instead of dealing with several bills (and possibly fighting off multiple debt collection agencies that are relentlessly contacting you), one lending bill is all that is necessary.

By consolidating debt, borrowers often experience a “weight” lifted from their shoulders. Debt consolidation, especially for personal loans, reduces borrower stress in several ways. It usually offers borrowers:

  • one monthly bill
  • a different interest rate
  • a longer term
  • a way to avoid debt collectors
  • an improved credit score

One Monthly Bill

On top of saving stamps and time, paying one monthly bill reduces unneeded stress. It is easy to lose track of financial requirements when multiple bills are coming in each month. When personal loans are consolidated, a borrower will know exactly how much he or she owes each week. Just as rent or mortgage payments are similar with each passing month, a consolidation loan is also a fixed and stable monthly bill.

One monthly bill also saves borrowers from picking and choosing which bills to pay. When a borrower has several bills with varying interest rates, it can confuse the decision-making process. Some borrowers might repay certain loans and default on others because they do not prioritize repayment for each loan accordingly. Consolidation loans prioritize all loans equally.

Additionally, because there is only one loan, if late payments are made, there is only one fine to pay.

Change in Interest Rate

Similar to most loans, the application process and interest rate received is based upon a borrower’s credit report. Although a lower interest rate is not guaranteed, it is possible to attain. This is particularly true if a borrower’s credit is higher when they consolidate than when the initial funding was acquired.

If the debt consolidation is unsecured and no longer linked to collateral, such as home equity, paychecks, or car titles, lenders may increase the interest rate to reduce threats on their end. In the end, a borrower might pay more for the interest, but their valuable collateral will no longer be linked to their loans.

In some instances, the interest rate will not improve but a fixed interest rate will be made available. Although fixed rates are gambles, they are safe and stable routes. For instance, if the market suddenly changes, fixed rates will provide the same interest year-after-year.

Longer Lending Terms

An additional financial perk to consolidation loans are payment extensions. Usually a loan’s lifetime is extended when debts are merged, giving the borrower more time to repay the debt.

This allows for reduced monthly payments, which is often a necessity when one is looking to merge existing debt. One downside, however, is that borrowers will now need to make payments for a longer period of time.

Avoid Debt Collectors

When debt is consolidated, harassing phone calls and letters from creditors should reduce significantly.

The payments that were open are now grouped together in one loan, so there is only one payment to deal with. If repayments are not made for the consolidation, debt collection calls may occur once again, but they will be coming from one source only.

Improved Credit Score

Although the initial act of consolidating debt does hurt a person’s credit history, in the long run, it could strengthen his or her score.

Credit scores will be re-established as a borrower’s current bills are paid with a debt consolidation loan. This will allow a credit score to grow, whereas unmanageable debt often leads to continuous defaults, which continually damage one’s score.

The benefits of consolidation loans are extensive, but just like any new loan, these tools should not be taken lightly. Similar to other unsecured borrowing, there are credit risks if monthly payments are not met. Consolidation loans do not allow borrowers to avoid payments on outstanding personal loans, but, they can provide stable and more manageable repayment plans.