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

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Dori Zinn is a personal finance journalist with more than a decade helping people understand money. Her work has appeared in Wirecutter, CNET, Credit Karma, Huffington Post, and more.
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Updated October 24, 2023
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A debt consolidation loan is a type of loan, which can be either a personal loan or a business loan. Most personal loans can be used for several potential purposes. However, if you have mountains of debt, whether it’s credit cards, medical bills, or something else, then debt consolidation loans are particularly useful for simplifying repayment.

Key Takeaways

  • Personal loans are usually unsecured installment loans. Debt consolidation loans are a type of loan, which can be either personal or business, that you can use to combine multiple outstanding balances into one.
  • You can use debt consolidation loans for most kinds of debt, including credit cards, outstanding medical bills, car repairs, and more.
  • If you need to borrow money for a purpose other than debt consolidation, you can take out a different type of personal loan.

Personal Loans

A personal loan is an installment loan that can be used to fund almost anything, including home repair costs, a wedding, adoption fees, paying back taxes, and more.

You’ll receive all of the loan’s funds in a lump-sum payment, and then you repay that loan over time in monthly installments until it’s repaid in full. Most personal loans are unsecured, which means interest rates are based on a borrower’s credit score and credit history, and you likely won’t need collateral to secure the loan.

Pros

  • Wide range of borrowing and repayment options

  • No collateral required for most types of personal loans

  • Interest rates are usually fixed, so monthly payments are predictable

Cons

  • No standard eligibility requirements; every lender and loan type is different

  • A high credit score is usually needed to secure the lowest interest rates

  • Different minimum loan amounts mean you may end up with more funds than you need

Debt Consolidation Loan

A debt consolidation loan is a type of loan that’s used to consolidate debt. Many debt consolidation loans are advertised as such—a borrower can typically use one to consolidate any kind of debt they have to streamline payments and save on interest in the long run.

A debt consolidation loan allows you to borrow an amount of money equal to the total of your outstanding loans to pay off all that debt at once. You then make one payment on your new loan each month, which has its own interest rate and repayment terms, typically lower than your existing APRs.

Although a debt consolidation loan makes it easier to handle payments by consolidating them into one, they may or may not save you money. If you sign up for an exceptionally long repayment term, you may owe just as much interest over time. Do the math to figure out how much it will cost over the life of the loan.

Pros

  • Streamlines outstanding debt into a single monthly payment

  • You’ll pay less interest over the life of the consolidated loan compared to having to repay several simultaneously, each with their own interest rate

  • Using a consolidation loan to pay off outstanding credit cards can free up your available credit

Cons

  • The hard inquiry from completing a loan application temporarily hurts your credit score

  • Loan approval depends on your credit score, income, debt-to-income (DTI) ratio, and more

  • Taking out a new loan decreases your average age of credit, which also impacts your credit score

Personal Loan vs. Debt Consolidation Loan: Which One to Choose?

Remember that debt consolidation loans can be either personal loans or business loans. Unless you’re taking out a debt consolidation loan out on behalf of a business, any debt consolidation loans that you apply for will likely be personal loans. As such, which one you ought to chose should be based on what you need the loan for.

You’ll want to get a debt consolidation loan if you:

  • Have a lot of outstanding loans with high interest rates, which are costing you more time and money in the long run
  • Can find an interest rate for a debt consolidation loan that’s lower than the interest rates of the debt you’re repaying right now
  • Have a few different outstanding loans and want to streamline your payments into a single monthly payment

A different kind of personal loan might make more sense if you need funding for any number of potential purposes, such as an emergency home repair, fixing your car, a down payment on a wedding venue, or something else. If your credit is good enough and you can make all the payments, you can even have several personal loans at once.

How Do I Qualify for a Debt Consolidation Loan?

For individual borrowers, a debt consolidation loan will typically take the form of an unsecured personal loan. This means that your credit score and history, debt-to-income (DTI) ratio, and employment status are used to determine your eligibility. How much you need to borrow and the expected repayment terms can also factor into your eligibility.

Can I Get a Debt Consolidation Loan if I Have Bad Credit?

Every lender has different eligibility requirements, but typically, the higher your credit score, the more likely you are to qualify for the lowest interest rate offered. A low credit score doesn’t mean your loan application will be rejected, but you’re more likely to have a higher interest rate on your loan.

Do Debt Consolidation Loans Affect Your Credit Score?

When you complete a loan application, a hard inquiry occurs as a result of the lender pulling your credit report to check your credit score and credit history. This, and the new loan reducing the average age of your credit history, will cause your credit score to temporarily decrease. But in most cases, your score will rebound after a few months of on-time payments. Your score will likely fall further if you make late payments or miss them entirely.

How Long Does Debt Consolidation Stay on Your Record?

Your debt consolidation loan stays on your credit report for as long as the account is open. Missed payments or accounts that go into delinquency or default, in addition to debt settlement agreements, can stay on your credit report for seven years or up to however long it takes to settle your outstanding debt.

The Bottom Line

Using a debt consolidation loan to pay off outstanding loans can be a smart way to reduce how much interest you would otherwise pay in the long run, in addition to making payments easier to manage. If you need money for more than just debt consolidation, you can use a personal loan to fund those needs.

Each lender has different eligibility requirements, so make sure to compare your options before submitting an application for either type of loan.

Article Sources
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  1. Consumer Financial Protection Bureau. "What Do I Need to Know About Consolidating My Credit Card Debt?"

  2. US Bank. "Everything You Need to Know About Consolidating Debts."

  3. myFICO. “What Is a Credit Score?”

  4. myFICO. “What Is the Length of Your Credit History?”

  5. myFICO. “Credit Checks: What Are Credit Inquiries and How Do They Affect Your FICO® Score?”

  6. myFICO. “What Are the Different Categories of Late Payments and How Does Your FICO® Score Consider Late Payments?”

  7. Federal Trade Commission, Consumer Advice. “Debt Collection FAQs.”

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