The biggest determiner of whether or not it’s financially savvy to take out a debt consolidation loan for the purpose of wiping out your other debts (like student loans or credit card debt) is how much it’ll cost you —with all interest charges over the life of the loan factored in. It only really makes sense to consolidate if you’ll end up saving money over the loan term compared to how much you’d pay just working down your current debts in the traditional manner.
As you’re comparing various loans you’ll likely notice a range of interest rates quoted to you. This may have you wondering: What determines debt consolidation loan rates, anyway? Having this information can help you optimize your financial situation before you apply. This can help you achieve the best results, as well as understand why you’re receiving certain interest rates based on your circumstances.
Average Debt Consolidation Loan Rates
First, it’s helpful to know what to expect on average for debt consolidation loan rates. According to NerdWallet, the broad range across lenders of all types as of late 2020 varies from about 5.5 percent to 36 percent.
So, what enables one borrower to qualify for a loan with a single-digit interest rate while someone else gets a rate at the higher end of this spectrum? For instance, a Bills.com debt consolidation loan for someone might have an interest rate around 10 percent while the same type of loan for their neighbor is closer to 20 percent APR.
Keep reading to learn more about the specific factors affecting consolidation loan rates.
What Lenders Consider When Setting Consolidation Loan Rates
Lenders set interest rates based on the perceived risk of the borrower being unable to satisfy the financial obligations, which means they closely consider the following factors when offering loans.
Credit Score: This is the predominant way lenders assess risk. Qualifying for the most competitive interest rates depends heavily on having a strong history of on-time payments and healthy credit utilization — and therefore a strong score, generally higher than 720 on the FICO scale.
This is why it’s a smart idea to ensure your credit reports from TransUnion, Equifax and Experian are error-free before applying. Furthermore, do what you can to satisfy late payments as soon as possible.
Debt-to-Income Ratio: Lenders are also going to examine how much money you owe vs. how much money you make. You can calculate your debt-to-income ratio (DTI) like this: Total recurring monthly debts (housing, transportation, credit cards, etc.) divided by gross monthly income before taxes.
The higher your DTI, the riskier you appear to lenders because so much of your take-home pay is already going toward dealing with debts each month. Therefore, the loss of that income could be more disastrous on your ability to keep up with payments.
Secured vs. Unsecured Loan: Some consolidation loans are unsecured, which means borrowers do not need to offer up a physical asset as collateral as they would if they were getting a secured loan on a home or car. However, there are some secured consolidation loans out there. Securing an asset against the loan a lender can confiscate if you default can help your chances of getting approved and lower interest rates — but on the flip side you’re putting an asset at risk if you falter on your loan payments.
Lenders will consider your credit score, income, debt levels and the nature of the loan — among other factors — when determining consolidation loan rates. Knowing this, borrowers can try to optimize their financial standing before applying for a loan and find the most competitive product for which they qualify.