Debt Consolidation vs. Personal Loan: What’s the Difference?

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A debt consolidation loan is a type of personal loan, but not all personal loans are debt consolidation loans. And a debt consolidation loan may have some restrictions that other personal loans don’t have.

Here’s what you need to know about the difference between a personal loan and a debt consolidation loan, and how to choose the one that’s right for you.

Key Differences Between Debt Consolidation and a Personal Loan 

What Is Debt Consolidation? 

A debt consolidation loan is used to pay off higher-interest rate debt, usually credit cards. When you receive the proceeds from the loan, you use the money to pay your credit card or other balances. Then, you pay off the debt consolidation loan, which will have a lower interest rate and shorter term than your previous debt. You’ll end up paying off your debt sooner and paying less interest.

There is one critical point to understand about debt consolidation loans. It is vitally important that, if you are paying off credit cards or other revolving debt, you do not use the credit you have just made available to charge more. Once you pay off your credit cards with the proceeds from the debt consolidation loan, do not carry a balance on those credit cards.

Debt consolidation loans can be obtained from:

• Banks
• Credit unions
• Online lenders
• Debt consolidation companies

Be sure you understand the interest rate and all the terms carefully before you agree to a debt consolidation loan. In some cases, the lender will pay your creditors directly instead of sending the money to you, and they may require that you close the accounts you are paying off.

What Is a Personal Loan? 

A personal loan is a loan that’s usually unsecured, meaning you don’t have to put up any collateral. Your application will be evaluated based on your creditworthiness, which includes your income and your history of paying what you owe on time.

When you take out a personal loan, you’ll get a lump sum of money from the lender when your application is approved. Then, you pay the lender back each month, with interest, until the loan has been paid off. Unlike credit cards, lines of credit or other revolving loans, you cannot ‘re-use’ the money you’ve paid off. For example, if you borrow $10,000 and pay back $5,000 of it, you can’t get another $5,000. 

You can use a personal loan for just about any reason. Common reasons include large expenses, like a wedding or vacation, educational expenses or emergency expenses. You can also get a personal loan from a bank, credit union or online lender, similar to debt consolidation loans.

How Does Debt Consolidation Work? 

Here’s how to get a debt consolidation loan.

1. Check your credit. Knowing your score will help you know where to apply.
2. Search for lenders that offer the best rates for your situation.
3. Once you’ve selected a lender, go online or to a branch to complete your application. You’ll need your contact information, proof of your income, and details on the debt you want to consolidate.
4. The lender will evaluate your creditworthiness. This can take a few days for online lenders, or up to a week or more for a bank.
5. If you’re approved, you’ll sign the loan documents. Read them carefully!
6. The lender will either give you the money or pay your creditors directly.
7. If you get the funds, pay your higher-interest debt right away.
8. Make monthly payments until the loan has been paid in full.

Remember, it’s important not to run up any more debt.

How Does a Personal Loan Work? 

Here’s how to get a personal loan.

1. Check your credit so you know where to apply.
2. Search for lenders with the best rates.
3. Once you’ve selected a lender, go online or to a branch to complete your application. You’ll need to provide your contact information and show proof of your income.
4. The lender will do a credit check and verify your application. This can take a few days for online lenders, or up to a week or more for a bank.
5. If you’re approved, you’ll sign the loan documents. Read them carefully!
6. The lender will give you a lump sum equal to the amount of the loan.
7. Make monthly payments until the loan has been paid in full.

A personal loan will increase your credit utilization score, which may cause your credit score to drop. Once you pay off the loan as agreed, your score should go back up.

Pros and Cons of Each Option 

Debt Consolidation Pros 

• Retire high interest debt
• Pay your debt off faster
• Pay less in interest

Debt Consolidation Cons 

• May be expensive if your credit is fair or poor
• You have to be careful not to run up a balance on your credit cards again 
• Make sure you can afford the payments

Personal Loan Pros 

• Money for large purchases or emergencies
• Less expensive than using a credit card
• No collateral required

Personal Loan Cons 

• Your credit score will probably go down
• Be sure the payments fit in your budget

How To Choose the Right Option for You 

Ultimately, the best option depends on your needs and where your finances currently stand.

If you have a lot of debt, it would be more convenient to keep up with your loans all in one place, consider debt consolidation.

On the other hand, a personal loan could be the right choice if you need quick access to cash to cover an unexpected expense or emergency.

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