Several loans can each look manageable on their own and still become a problem together. Every lender has its own due date, charges and way of collecting.
A borrower can end up juggling payments, and one missed date can bring a late fee or a call from a collector. Debt consolidation is one way to simplify that picture, but it only helps when the numbers work.
This article explains what a debt consolidation loan is, why borrowers turn to one, how it works, what it can cost, how lenders assess requests, and eight steps for getting one.
What a debt consolidation loan is
A debt consolidation loan is money you borrow to pay off your separate loans, so that you repay one amount over time.
The CFPB, the US consumer finance regulator, explains that banks, credit unions and other lenders offer these loans, and that the new loan might carry a lower interest rate than the debts it replaces.
Here is an example. A borrower owes 350,000 to a bank, 180,000 to a digital lender and 170,000 to a cooperative, which makes 700,000 in total.
A new lender approves a loan large enough to settle all three. The borrower clears the old balances and then repays the new lender on one schedule.
The real amount needed may be higher. Each creditor can add accrued interest, fees or an early settlement charge, so a borrower should ask for a settlement figure from each one before applying.
Consolidation does not erase debt. It changes who is owed and on what terms.
It also differs from debt settlement, where a company negotiates to pay a creditor less than the full balance, and from credit counseling, where an adviser helps you build a repayment plan. The CFPB page covers all three.
Why borrowers turn to consolidation
Digital lending has made small loans quick to get. A borrower can apply to a bank, a microfinance lender, a loan app, an employer scheme and a cooperative. Each sets its own due date and price.
Borrowing from several can feel convenient at first, because every loan solves a problem on the day it is taken. Over time the repayments pile up and take a large share of income.
Income that moves around makes this harder. A trader may owe a repayment before the stock it paid for has sold. A salaried worker may face several deductions before payday.
When money runs short, some borrowers take a new loan to cover an old one. That habit is called loan stacking, and it can turn a manageable debt into a heavy one.
The numbers show how common the strain is. CGAP’s guide to responsible digital credit reports 2024 phone surveys in four African countries.
Among digital borrowers, 86 percent in Kenya, 70 percent in Tanzania, 55 percent in Ghana and 53 percent in Côte d’Ivoire said they faced repayment challenges, and defaults ranged between 17 and 46 percent.
An earlier CGAP survey in Kenya found that 14 percent of digital borrowers were repaying loans from more than one provider at once.
For lenders, consolidation is a chance to serve customers who carry several debts but can still afford a new loan on better terms. The idea works in any market, adjusted for local rates and credit reporting.
How a debt consolidation loan works
The borrower starts by listing the debts to combine and getting a settlement figure from each creditor, because the amount needed to close an account is often higher than the balance on a statement.
They then apply to a lender and share their income and current repayments. The lender checks the borrower’s income, other debts and repayment record, and decides whether to approve the loan and for how much.
If the lender approves, the money goes to settling the chosen debts. Some lenders pay the creditors directly, which keeps the money on track.
Others send the funds to the borrower, who pays each creditor. Either way, the borrower should get written confirmation that each account is closed. After that, one schedule replaces many.
Benefits
The first benefit is simplicity. One due date and one payment are easier to track than several, and the borrower is less likely to miss a payment.
The second is potential savings. A consolidation loan costs less only if its rate and fees are lower than what the old debts would cost over their remaining life.
The Australian government’s Moneysmart site says consolidation helps when you pay less in total, when the new loan does not run longer than your current debts, and when you can afford the repayments.
The third is a schedule that fits income. A salaried worker may want a payment date just after payday. A trader may need a term that matches how long stock takes to sell. The lender still has to confirm that the borrower can meet each payment.
The fourth is a clear end date. One loan has one finish line, so the borrower knows the month the debt will be gone. Moneysmart lists a clear end date among the signs that consolidation can help.
The fifth is fewer chances to pay late. Each due date is a chance to miss a payment and trigger a penalty, so fewer dates mean fewer risks.
Read more: How to use psychological triggers in your debt collection messages
Risks
The biggest risk is paying more over time. A lower monthly payment usually comes from stretching the loan over more months, and every extra month adds interest.
Moneysmart’s example shows the effect. A 20,000 loan costs 25,496 in total at 10 percent over five years. At 8 percent over ten years it costs 29,119, and at 6 percent over fifteen years it costs 30,379. The monthly payment falls from about 425 to about 243 to about 169, yet the total cost rises each time.
Fees are the second risk. Origination charges, insurance and early settlement charges on the old loans can eat into any savings. A 2 percent origination fee on a 700,000 loan is 14,000 before the borrower has repaid anything. Ask for a written breakdown of every charge before you accept.
New borrowing is the third risk. A borrower may treat the cleared accounts as fresh room to borrow. If they take new loans, they end up with the consolidation loan plus new debts. Moneysmart adds a warning about secured loans, since missed payments can cost the borrower the asset that secures the loan.
Approval is the fourth risk. A borrower who is already behind, has unstable income or carries heavy debt may be turned down or offered only an expensive loan.
A lender that approves an unsuitable loan anyway can make the borrower’s position worse and raise its own default risk.
How to get a debt consolidation loan: eight steps
Step 1: List every debt
Write down every debt you might include: the lender, balance, interest rate, due date, instalments left and any overdue charges. Include bank loans, digital loans and cooperative borrowing.
Step 2: Ask for settlement figures
Ask each creditor what it would take to close the account on a set date. A statement balance often leaves out accrued interest and fees, so the settlement figure can be higher. Some debts may be cheaper to keep paying as they are.
Step 3: Check your income and essential costs
Work out what is left each month after housing, food, transport, utilities, school costs and necessary business spending. If your income varies, average several months and avoid using your best one.
Step 4: Compare offers on total cost
Compare each offer on rate, fees, term, instalment and total amount payable. The total is the number that matters, because a smaller instalment can hide a bigger cost. Ask whether the lender pays your creditors directly.
Step 5: Apply with accurate information
Expect to share identification, proof of income, bank statements, details of current loans and consent for a credit check. Declare every debt. A lender that finds an undeclared loan later may reject the application.
Step 6: Read the agreement
Check the amount, how interest is calculated, the fees, the due dates, the late-payment penalty and the terms for repaying early. If the new loan costs more in total than the old debts, ask for a shorter term or lower fees, or decline.
Step 7: Settle the old debts and get proof
After disbursement, pay each creditor the agreed figure. Keep receipts and get written confirmation that each account is closed. Follow up on any account that still shows a balance, because it can keep adding interest and fees.
Step 8: Follow the plan and stop adding debt
Set aside the repayment before discretionary spending. If your income swings, save more in strong weeks to cover weak ones. Avoid new loans unless the need is clear, since consolidation only works if the old debts stay paid off.
How lenders should assess a consolidation request
The amount requested tells a lender little on its own. Start by confirming the purpose and getting evidence of the balances to be settled. Use credit bureau data, bank transaction history and other lawful sources to check repayment patterns and existing debts.
Alternative data helps with customers who have thin credit files, but it needs care. Irregular deposits, transfers between a person’s own accounts and one-off receipts can overstate income if the lender does not check where the money came from.
Affordability comes next. A borrower who earns 250,000 in a typical month may have little room for a new installment once household and business costs are paid.
Lenders should test whether the borrower could still pay in a weaker income month.
Where the product allows it, paying creditors directly helps the loan do its job. The lender should also give clear disclosures and keep accurate records of disbursement, settlement and repayment.
How Lendsqr supports the assessment
Lenders on Lendsqr can see more of a borrower’s picture before approving a consolidation request.
The credit bureau lookups in Lendsqr’s developer APIs can show existing debts, and its decision models then apply the lender’s own approval rules, such as a limit on how much income may go to debt repayments.
Repayments can be collected by direct debit. To try it, sign up for a Lendsqr account.
When consolidation is not the answer
Consolidation works best for a borrower with several debts, a dependable income and access to a loan on affordable terms.
Other borrowers may do better to contact their creditors first. A creditor may agree to a new payment date, a longer term or a smaller installment.
A nonprofit credit counsellor can also help with a budget and, in some markets, a debt management plan with one monthly payment, as the CFPB page describes.
When a borrower cannot cover basic costs and a realistic repayment together, a new loan only adds pressure.
Read more: What to look for in a debt collection software
Weigh the cost before you consolidate
A debt consolidation loan turns several debts into one repayment. That can lower costs and make budgeting easier, but only when the new loan costs less in total and fits the borrower’s income.
Before borrowing, a borrower should add up the balances, get settlement figures and compare offers on total cost. Afterwards, they should avoid taking on new debt.
Lenders should verify existing debts, test affordability and explain the terms in plain language. When both sides understand the costs, consolidation can make repayment manageable.
