Personal Loans vs. Debt Consolidation
Personal loans and debt consolidation are similar but different ways to manage debt. Understanding when to use a personal loan vs. when to consolidate debt can help you make the best financial decision.
A personal loan is a way to borrow a fixed amount of money and pay it back in monthly installments. Most personal loans are unsecured, so you get approved based on your credit history without collateral.
You can use the funds from a personal loan for almost anything, including vacation, medical bills, and home improvement projects. Some lenders set their restrictions; for example, you might not be able to use a personal loan for investments or college tuition. Many personal loans do have minimum or maximum limits. As of early 2023, the average interest rate for a personal loan is about 10.7%, but this can vary depending on your credit score. View ProFed's current personal loan rates here.
Read more about personal loans and credit cards in ProFed’s article, Personal Loans vs. Credit Cards: Pros and Cons.
Debt consolidation is a personal finance tactic in which you take out a new loan to pay off your debts. For example, if you owe $15,000 on three credit cards, you could take out a $15,000 debt consolidation loan and use that money to pay off your credit card balances. Then, you would only need to make one monthly payment instead of three, simplifying things. Depending on your credit history, the new debt consolidation loan might have a lower interest rate than your credit cards. This will reduce the overall cost of the loan, save you money and make it easier to pay the loan off.
Debt consolidation loans are one of many ways to combine debt, typically reducing your monthly payment. Credit card balance transfers and home equity loans are also popular options. To do a credit card balance transfer, you would open a new credit card and use this card to pay off the balances on your other cards. If you own your home, you may be able to take out a home equity loan, which uses the equity you have in your property as collateral. Often, home equity loans have lower interest rates than other loans.
Personal Loans vs. Debt Consolidation
Debt consolidation loans are for paying off existing debt. Types of debt consolidation loans include personal loans, credit card balance transfers, and home equity loans. With debt consolidation, you will pick the loan type to help consolidate your debt for a better interest rate, combine the debt into one lump sum, and pay it back in monthly installments.
Personal loans can be used for personal use or small projects. With personal loans, you'll take out a certain amount of money at a fixed or variable interest rate and pay it back in monthly installments.
If you're dealing with overwhelming debt, consider using a ProFed calculator to determine if consolidating your debt into one loan would benefit you. Talking to a ProFed expert can also help you decide your best next step when evaluating different loan types. Contact ProFed Credit Union, or schedule an in-person or virtual meeting to discuss your loan options today.