Debt consolidation loans for bad credit: What are your options?
When bad credit and mounting debt create the perfect financial storm, there's still hope on the horizon.
Contributing Writer at Tally
May 14, 2020
If you find yourself buried in debt with high interest rates, digging out of it can become overwhelming. Unfortunately, a bad credit rating tends to accompany that mounting debt, eliminating some of the best debt consolidation loan options.
No need to throw your hands in the air and give up on getting out of debt, there are debt consolidation loans for bad credit.
Below, we'll outline your best debt consolidation loan options and a few alternatives. But first, let's look at what debt consolidation is and what its benefits are. We'll also take a look at what bad credit is and where you fall on the credit score spectrum.
Debt consolidation loan defined
Simply put, a debt consolidation loan is a fixed rate personal loan you receive to pay off multiple unsecured debts — typically, high-interest debt like credit cards or payday loans. This loan often offers a favorable APR compared to your credit cards' high interest rates, and simplifies your financial life by rolling multiple monthly payments into one.
Another benefit of a debt consolidation loan is that it includes fixed repayment terms. You know you'll pay off this loan in a specific time frame, generally 3-5 years.
Debt consolidation loans for bad credit take on various forms, including traditional personal loans, secured loans, lines of credit and more.
Bad credit defined
There are many credit scoring models, but the most common is the FICO model. In the FICO model, your credit score can range from 300 to 850, so there's a lot of wiggle room in there.
Bad credit can be subjective: Someone who's always had an 825 credit score may think a 700 is bad, while someone who's never had more than a 550 score may see a 650 as good.
FICO eliminates subjectivity by officially placing the good credit score cutoff at 670. Anything below a 670 is officially a bad credit score.
That said, FICO has two stages of bad credit. If you have a 580-669 credit score, FICO places you in the "Fair" category. A credit score under 580 puts you in the "Poor" credit category.
Getting a debt consolidation loan for bad credit
Getting a debt consolidation loan for bad credit can be tricky, as these personal loans generally require good credit to get approved. That said, there are some options to help you get the debt relief you need.
Get a co-signer
You may lack the good credit needed to get a debt consolidation loan, but you might know someone who has the credit to get approved. If you have a good enough relationship with that good-credit individual, ask them to co-sign for your loan. In many cases, a lender is willing to overlook your less-than-favorable credit report if there's a co-signer with a good credit history.
There are a few considerations to keep in mind when approaching a co-signer. While they won't have to make your monthly payments for you, this personal loan will appear on their credit report. It will impact their debt levels, and a missed payment will show as a negative mark on their credit report.
You must consider these potential downfalls, as they mean you'll likely need a good relationship with the co-signer for them to agree to it. You should also account for the fact that you could erode the relationship should you miss a payment and damage their credit.
Ask your bank or credit union
While your bad credit may get you stonewalled by traditional debt consolidation loan providers and other online lenders, there are other options. One option is going to a familiar place: your bank or credit union. If you've had a long relationship with your bank or credit union, the institution may be able to make some exceptions for your low credit score and get you approved.
Keep in mind, though, the bank may request certain commitments from you. These commitments may include placing a certain amount of money in a certificate of deposit account — a savings account that must have a minimum balance for a fixed number of years, like $5,000 for 5 years — or you may have to authorize automatic monthly payments directly from your account.
Secure a line of credit
A third-party line of credit may be another option. The Tally line of credit is one option, as it only requires a minimum credit score of 660.
Tally can help by offering you a line of credit account at a lower interest rate that you can use to pay off your high-interest credit card debt. Since this is a revolving credit account, you can use it again and again to pay off multiple credit cards over time.
On top of this lower interest rate, the Tally Advisor feature analyzes your spending habits and creates a repayment plan to get you out of debt as quickly as possible. Tally Advisor adjusts to your needs, so you never feel forced into unconformable financial situations.
Tally also handles all your credit card payments for you. You make one payment to Tally, and Tally uses its line of credit to pay your credit cards, streamlining repayment and helping you avoid late fees.
Look into a secured loan
Secured loans may work as debt consolidation loans for bad credit. To get a secured loan, you must put up an asset as collateral in case you default on the loan. Generally, this asset is a vehicle, home or another high-value item you own.
Most lenders require the asset to be worth at least the value of the loan, so if you want a $20,000 loan and plan to use your vehicle as collateral, your vehicle must be worth at least $20,000.
Secured loans come from a wide range of sources, including banks and credit unions, debt consolidation companies, vehicle title loan companies and even pawn shops. Keep in mind that these types of loans generally come with high interest rates, so read the loan terms carefully to ensure it makes financial sense. Vehicle title loans and pawn shops tend to offer particularly unfavorable terms, including high fees and interest rates, so consider them only as a last resort.
Consider a 401(k) loan
If you've been employed and contributing to a 401(k) for years, you can use that retirement savings to your advantage today. A 401(k) loan is an interesting debt consolidation loan option, as it not only gives you quick access to cash with no credit score requirements, it's also almost free of cost to you.
Sure, there is an interest rate attached to a 401(k) loan, but since you're borrowing your own money, those interest payments go into your 401(k) and not to a lender. Plus, there is generally no origination fee associated with a 401(k) loan.
There are a few downsides to consider when looking into a 401(k) loan, though:
You will stop earning interest on the amount you borrow, potentially impacting your security in retirement.
Some plans will not allow you to make 401(k) contributions while repaying a loan.
Repayments come from after-tax dollars.
There is a cap on what you can borrow from your 401(k) — as of April 2020, that cap is the lesser of $50,000 or 50% of the 401(k) account's value.
Lower your loan amount
With bad credit and a large amount of high-interest debt, it can be hard to get approved for a loan amount that covers all your debt. Instead of trying to knock out all your debt with one loan, try getting a smaller loan amount to pay off a portion of your debt.
As you pay off your debt, your credit utilization will drop, increasing your credit score. This score increase should open you to higher loan amounts in the future. Repeat these smaller loan amounts until you pay off all your credit card balances.
For example, if you have $10,000 in debt, try taking out a $5,000 loan to pay off half of that debt initially. Once you pay off that first $5,000 loan, take out a new loan for the remaining balance.
Use a 0% balance transfer card
Though you may have a low credit score now, you may have had a good score before and accumulated a handful of credit cards. If one of those cards offers a 0% balance transfer option, you have access to a favorable debt consolidation option.
Roll as much of your credit card balances as you can onto this balance transfer credit card and use the 0% interest rate to help pay off this debt quicker. You may not be able to consolidate all your high-interest debts onto this card, but it can help cut down your credit utilization ratio and increase your credit score, which can open you to more traditional debt consolidation options in the future.
Most balance transfer cards charge a 3-4% balance transfer fee. So, if you transfer $5,000 in credit card debt to this card, you will incur a $150 to $200 fee. Also, remember the 0% terms are generally limited to 12-18 months, after which you'll start accumulating interest again.
Even with bad credit, you have options
Despite a poor credit rating, there are still plenty of debt consolidation loan options available to you. Some, like the balance transfer card, 401(k) loan or secured loan, may be less traditional and may not be the best debt consolidation loans.
These options generally come with less favorable terms than what's available to those with good credit. So, read the terms carefully, make sure the loan comes with lower rates than your credit cards and consider taking out only small loans to start — even if they don't cover the full amount of your debt.
As you pay down your debt, your credit score will rise, opening you to more favorable options like an unsecured loan or a line of credit. Paying down your debt is the first step toward paying off your debt.
The key is to start now. The sooner you start paying off your debt, the faster you get on the path to good credit and better loan terms, reducing interest rates and saving you money.