If you are struggling to make ends meet, a debt consolidation loan can streamline your payments and help you save money. Whether you lost your job because of the coronavirus pandemic or simply spent beyond your means, this type of loan rolls all of your debts into a single payment.
A debt consolidation loan can make sense on two conditions, says Michael Sullivan, personal financial consultant at the Phoenix-based nonprofit credit counseling agency Take Charge America. The first is that the loan must offer significant savings compared with what you are paying on your credit cards, and the second is that you will need the discipline to pay it off without creating more debt.
Debt consolidation loans tend to work best for borrowers who have managed debt well but fallen on hard times because of a job loss, medical emergency or other crisis, Sullivan says. Unfortunately, landing one of these loans can be difficult if you have bad credit.
"A consumer with good credit can currently take out an unsecured loan for 6% APR or less," Sullivan says. "A consumer with poor credit can expect to pay over 30%."
Here's more about getting a debt consolidation loan.
[Read: Best Debt Consolidation Loans.]
Debt Consolidation for Bad-Credit Consumers
If you have a long history of late payments and charge-offs, you may struggle to obtain a debt consolidation loan.
Lenders may fear that they won't be repaid and charge borrowers with bad credit higher interest rates to compensate for this risk, Sullivan says. "Some consumers will be unable to secure a loan from a bank or credit union on any terms," he says.
Sometimes a subprime lender is your only option if you have bad credit and you want a debt consolidation loan, says credit expert John Ulzheimer, formerly of FICO and Equifax. "This is fine, except the cost to service your loan will be higher -- perhaps much higher," he says.
Ulzheimer says you have to ask yourself whether you're actually benefiting financially with such a high APR.
[READ: Best Bad Credit Loans. ]
Boosting Your Odds of Approval for a Debt Consolidation Loan
Raising your credit score is one of the best ways to improve your chances of getting a debt consolidation loan. But you will need to be patient.
"You could always wait until your credit scores are better before you apply, but that can take several years," Ulzheimer says.
Borrowers with credit scores of more than 720 -- squarely in FICO's good range -- receive the best terms, Sullivan says. If your credit score is subpar, obtaining a loan with reasonable terms can be a challenge.
"Consumers with a score below 640 have proven that they do not reliably repay loans and are not good candidates for additional loans," he says.
The credit bureau Experian notes that once your FICO score dips below 580, you are especially likely to struggle to land a debt consolidation loan.
You could look at relationships you might have with banks and other lenders if you do not have the luxury of waiting for your credit score to rise, Sullivan says. A relationship might open the door to a loan.
"If a consumer has a positive history with a lender, it might be possible to get a loan that is somewhat better than those offered on the open market," he says.
If that avenue comes to a dead end, consider asking family members and friends to recommend lenders. And then if you still can't find a lender, you could look online at loan offers for consumers with poor credit, Sullivan says.
"Comparing at least five of these sources should make it clear if a source of money exists at a reasonable cost," he says.
Finally, consider working with lenders known for looking beyond credit reports and scores to approve loans. Online lenders such as Upstart and LendingPoint may approve you for a debt consolidation loan, according to Experian, if you have solid employment and income history, for example.
Potential Risks and Limitations of Debt Consolidation Loans
Even if you manage to find a lender that will work with you, a loan may not solve all of your problems, Ulzheimer says.
"The goal of a consolidation loan should be to convert all of your expensive credit card debt into less expensive installment debt," he says. "If your credit is too bad, then you may not qualify for a large enough loan to pay off all of your credit card debt."
Also, some debt consolidation loans have low initial interest rates -- known as teaser rates -- that may adjust higher, the Consumer Financial Protection Bureau cautions. That means you could end up paying more on your consolidated debt than you did on your individual debts, particularly if loan fees or other costs push up your total expenses.
Some debt consolidation loans lower your monthly payment by stretching out the repayment timeline. But this can result in paying more in interest on the loan over time.
You may also need to pay "points" on top of interest charges, the Federal Trade Commission notes, which can push up the cost of a debt consolidation loan. One point is equal to 1% of the amount you are borrowing.
[Read: Best Personal Loans.]
Alternatives to Debt Consolidation Loans
If a debt consolidation loan is too costly, you might want to seek alternatives. But keep in mind that approval could still be tricky.
The right balance transfer credit card, for instance, can be a good option for lowering your debt costs, Ulzheimer says. "You may be able to open a new card that has a zero-interest grace period long enough that you can pay off your credit card debt before the expiration of the grace period," he says.
However, poor credit can make getting approved difficult, Ulzheimer says. "Poor credit really limits your options and makes them more expensive and restrictive," he says.
If you're unsure whether to pursue a debt consolidation loan or an alternative, you could reach out to a reputable credit counseling agency.
A counselor can help you create a plan to repay creditors and may suggest a debt management plan, or DMP. With a DMP, the debt counselor can reach out to your creditors to see if they will agree to reduced monthly payments or possibly interest rates.