Personal Loan vs. Debt Consolidation: Which is Right for You?

Navigating through a debt consolidation loan sometimes takes time before you feel comfortable with the details. A personal loan is simply a single loan you can choose to use for debt consolidation or other purposes. If you want to consolidate your debts, you should evaluate various options before agreeing to take on a new loan.

Personal Loan

A personal loan is a loan a lender gives a borrower, typically for a low amount and without requiring a security agreement or collateral. For example, if you take out a car loan, the lender typically requires that you give it a security interest -- a lien -- in the car. If you take out a personal loan to buy a car, the lender doesn't usually require you to provide collateral or a security agreement. Personal loans, for this reason, often come with higher interest rates than secured loans.

Debt Consolidation

If you want to combine your debts so you can make one monthly payment instead of several, you must obtain a new loan and use it to pay off your other debts. For example, you can take out a home equity loan (which is a secured loan) and use the money to pay off any other debts. Once this is done, you no longer have to make payments to the old creditors. Instead, you have to pay the creditor who gave you the home equity loan. Debt consolidation is helpful if the interest rate of the consolidating loan is lower than the rates of the debts you intend to pay off.

Loan and Consolidation

You can use a personal loan to consolidate debts. For example, if you take out a personal loan and use the money to pay off two credit card balances, you've effectively consolidated your credit card debt with the personal loan. However, because personal loans usually come with higher interest rates than secured loans, they are not always a suitable choice for a consolidation loan, as they cost you more in the long run.

Evaluation

Whenever you take out a personal loan to consolidate debt or any other kind of loan, you should evaluate the loan terms carefully. A personal loan is still a loan and you must pay it back. Consider the terms of any loan agreement with regard to your needs and ability to repay the loan. If you need help, talk to a credit counselor or financial adviser in your area.