How Are Debt Consolidation Loans and Personal Loans Different?

Quick Answer

Lenders may advertise their unsecured personal loans as debt consolidation loans to attract customers who are looking to consolidate debt. However, the loan itself isn’t any different than a personal loan you take out for other purposes.

Couple sitting on the couch reviewing paperwork for a secured loan

A debt consolidation loan is simply a loan that you use to pay down multiple debts—the name refers to how you use the money, not the type of loan. Many people use unsecured personal loans this way, and you'll likely come across lenders that advertise their personal loans as debt consolidation loans.

What Is the Difference Between a Personal Loan and a Debt Consolidation Loan?

All debt consolidation loans are personal loans, but not all personal loans are debt consolidation loans.

Personal Loans

A personal loan is a type of installment loan that you can use for almost anything. You receive the entire loan amount upfront and then repay it with periodic (often monthly) installment payments over a predetermined repayment period. Some lenders charge an origination fee on the loan, but there's generally no penalty for repaying the loan early.

Aside from consolidating debt, people often take out personal loans to pay for major expenses, including medical bills, car repairs, home repairs, weddings and vacations. You often don't need to use the money for a single, or even a specific, purpose. But some lenders may place a few limitations on loan uses. For example, you might not be allowed to use the proceeds for educational expenses, to buy investments or to do anything illegal.

Personal loans typically range from $1,000 to $20,000, but some lenders offer loans for as much as $100,000. Most personal loans are also unsecured, meaning you'll qualify for the loan solely based on your creditworthiness (credit history, credit score, income and debts).

With a secured loan, such as a mortgage or auto loan, you have to use your property as collateral and the lender can seize it if you don't repay the loan. But some lenders do offer secured personal loans, which are secured by money that's locked in a savings account, certificate of deposit or investment account at the lender.

Debt Consolidation Loan

A debt consolidation loan is a personal loan that you use to pay down (or off) other debts. By using one loan to pay off others, you're consolidating multiple bills into one.

While lenders sometimes highlight the benefits of debt consolidation when marketing personal loans, such as lowering your monthly payment or interest rate, there's no special debt consolidation loan. Your decision to use a personal loan to pay off other debts makes it a debt consolidation loan.

You can also use other types of loans to consolidate debts, such as a personal line of credit, home equity loan or home equity line of credit. But debt consolidation is often advertised as one potential way to use those types of accounts, rather than an alternative name for the loan or line of credit itself.

When to Use a Personal Loan

While you can use a personal loan for almost anything, some uses may be better than others. Debt consolidation is one of the better options, as we'll explore, and paying for a major life event could be a good option. You also may be able to get a personal loan within a day or two and cover emergency expenses if you're in a pinch and don't have an emergency fund.

In general, it's best not to use a personal loan for consumer purchases if the payments will make it difficult to afford your other bills. Even when you can afford the payments right now, the debt could increase your debt-to-income ratio and make getting another loan more difficult or expensive.

Benefits of a Debt Consolidation Loan

If you're paying down multiple debts, you may benefit from a debt consolidation loan in several ways:

  • Fewer monthly payments: The convenience of replacing multiple bills with a single monthly payment could be reason enough to consider a debt consolidation loan.
  • Fixed interest rate: Most personal loans have a fixed interest rate, which means rising interest rates won't lead to a higher rate or monthly payment on your loan—like rising rates do with credit cards.
  • Interest savings: Your personal loan may also have a lower interest rate than your current debts, which could help you save money. In the first quarter of 2022, credit card holders who were paying interest had an average 16.44% annual percentage rate (APR) on their cards, but a 24-month personal loan had an average 9.41% APR, according to Federal Reserve data.
  • Lower monthly payments: Your monthly payment will depend on your loan amount, rate and repayment term. Choosing a longer term can lead to a lower payment and free up your money for other expenses, but longer payments also lead to paying more interest overall.

As with other types of credit, your loan offers' terms will depend on your creditworthiness. Borrowers with FICO® Scores in the very good (740 to 799) and exceptional (800 to 850) ranges can expect to get the best deals on personal loans and credit cards alike.

How Does a Personal Loan Affect Your Credit Score?

Opening a new credit account often affects your credit score in different ways. Some of these may help your credit, and you'll generally be able to improve your credit score if you're making payments on time and paying down debt. But opening a new account can also hurt your score in several ways.

How a Personal Loan Can Improve Your Credit

A personal loan can improve your score in the following ways:

  • It lowers your credit utilization ratio. Paying down credit card debt lowers your credit utilization ratio—a comparison of your cards' balances and credit limits. Credit utilization can have a big impact on your credit scores, and a lower utilization is best.
  • You'll have fewer accounts with balances. If you're paying off other loans and credit cards, you'll have fewer accounts with a balance, which could be good for your score.
  • You'll potentially add to your credit mix. Having a mix of revolving and installment accounts—your credit mix—could also be good for your score.
  • It will help establish a positive payment history. Making your loan payments on time can add more positive payment history to your credit report.

How a Personal Loan Can Hurt Your Credit

You may notice your score drop when you take out a personal loan because:

  • You'll have a new hard inquiry. Applying for a personal loan can lead to a hard inquiry, which may temporarily hurt your credit score by a few points.
  • It decreases the average age of your accounts. The new loan will lower the average age of your credit accounts—a higher average age is best.
  • You may have a high-balance account on your report. While a high-balance installment loan isn't as bad for your score as maxed-out credit cards, it could still be a negative factor if you need credit in the near future.
  • Missed payments count against you. While this isn't unique to personal loans, remember that missing even one payment could significantly hurt your score. On the flipside, making all payments on time can go a long way toward helping your score.

If you use a loan for debt consolidation, resist the temptation to run up new balances on the credit cards you paid off with the loan. Making card and loan payments could put you over budget, undo the credit score benefits of lowering your utilization rate and defeat the original purpose for the loan.

Alternatives to a Debt Consolidation Loan

A personal loan isn't the only option if you're looking to consolidate debts. Before applying, also consider the following alternatives and whether they might be a better fit.

Other Types of Loans

Consolidating unsecured debt (such as credit card debt) with a secured loan isn't necessarily a good idea because you're taking on the additional risk of potentially losing your collateral if you miss payments. However, if you have a large repair or home upgrade, you may want to compare using a personal loan with a home equity loan or line of credit for this purpose. While these types of second mortgages can have longer application processes and higher closing fees than personal loans, they may also offer more favorable rates and tax benefits if you're significantly improving your home.

Balance Transfer Credit Cards

Some credit cards offer new cardholders a promotional interest rate on balances that you transfer to the card. These balance transfer cards may give you an introductory 0% APR on transferred balances for around 15 to 21 months. While there's often a 3% to 5% balance transfer fee, you could still come out ahead as you'll be avoiding new interest charges while paying down the balance.

Review the offer's terms carefully to make sure this is a good option. For example, if the card doesn't also have a promotional rate for purchases, any new purchases may start to accrue interest right away. Also, keep in mind that you might not be approved for a high enough credit limit to transfer all your debts.

A Debt Management Plan

Some nonprofit credit counseling organizations offer debt management plans (DMPs) as a service if you have unsecured debts—generally, credit cards. After meeting with a credit counselor to discuss your debt and options, you may be able to enroll in a DMP, and the counselor will reach out to your credit card issuers to try and negotiate better repayment terms, such as lower interest rates and waived fees.

With a DMP, you'll make a single monthly payment to the counselor, who will distribute payments to your creditors. The plans generally lead to paying off your debts within three to five years, and they could save you money overall and free up cash for other purposes. However, you may also have to close your credit card accounts and avoid opening or using any credit cards while you're part of the DMP, which could cause your credit score to drop.

Debt Settlement

Debt settlement companies offer to negotiate with your creditors to settle your outstanding debts for less than you currently owe—and often collect a portion of your savings in return. While there are some legitimate companies, debt settlement should only be considered if you're already behind on payments and can't utilize other consolidation options.

You're generally instructed to stop making payments, which can hurt your credit and lead to additional fees. And these negative marks and fees can stick even if the debt settlement company isn't able to negotiate a favorable settlement.

Research companies before enrolling or paying to ensure the company is legitimate and reputable. You could also try negotiating a settlement on your own before contacting a debt settlement company.

See Your Debt Consolidation Loan Offers

You can check your personal loan offers before accepting a loan and paying off other debts. Comparing your offers can help you determine which lender will give you the best deal—which might mean the lowest interest rate or highest loan amount, depending on your situation. If you don't want to go lender-by-lender to compare offers, you can use Experian CreditMatchTM to get personal loan offers based on your unique credit profile.