Personal Loans for Debt Consolidation: The Math, Including the Origination Fee
Replacing high-rate card debt with a fixed-rate personal loan can save thousands and set a payoff date. The origination fee and the temptation to reuse the cards decide whether it works. Here is a worked example.
A debt consolidation loan is a personal loan used to pay off other debts, usually credit cards, leaving one fixed monthly payment at a fixed rate with a set payoff date. When the loan's rate is meaningfully lower than the cards' rates, consolidation can save a lot of interest. When fees are high or spending resumes on the cleared cards, it can make things worse.
The short version
- A personal loan replaces several variable-rate balances with one fixed payment and a payoff date.
- Origination fees are often deducted from the loan amount, so you may need to borrow more than you owe.
- In our example, consolidating $15,000 of 23% card debt into a 36-month loan at 12% with a 5% fee costs about $3,880, compared with about $6,948 in interest paying the same monthly amount on the cards. That saves about $3,068 and finishes six months sooner.
- The fee raises the loan's effective cost: 12% with a 5% fee works out to about 15.6%.
- The plan fails if the cleared cards get used again.
The example
A hypothetical household owes $15,000 on credit cards averaging 23% APR. They're offered a 36-month personal loan at 12% APR with a 5% origination fee deducted from the proceeds.
Now compare paying the same $524.44 a month on the cards at 23%:
| Keep paying cards | Consolidation loan | |
|---|---|---|
| Monthly payment | $524.44 | $524.44 |
| Months to debt-free | 42 | 36 |
| Total interest and fees | about $6,948 | about $3,880 |
Show the numbers behind this chart
| Interest and fees | |
|---|---|
| Cards at 23% | $6,948 |
| Personal loan at 12% + 5% fee | $3,880 |
The origination fee changes the real rate
A 5% fee taken upfront means you pay interest on money you never receive. Converting the fee into an effective rate:
Lenders must disclose the APR, which for many personal loans includes the origination fee. Compare APRs across offers, not just the interest rate. Some lenders charge no origination fee; others charge several percent.
When consolidation tends to work
- The loan's APR is clearly lower than the weighted average rate on your debts.
- The monthly payment fits your budget reliably.
- You've addressed the spending that created the balances.
- You want a fixed payoff date and one payment instead of several.
When it often doesn't
- The rate offered isn't much lower than your cards, or fees are high.
- A longer term lowers the payment but raises total interest, possibly above what you'd pay on the cards with a disciplined plan.
- The cleared cards are used again, leaving you with the loan plus new card balances.
- The debts already have low or 0% promotional rates.
Alternatives
- Balance transfer cards with 0% promotional rates; see balance transfers.
- Paying down cards directly using the avalanche or snowball method; see debt avalanche vs. snowball.
- Nonprofit credit counseling and debt management plans.
- Home equity borrowing, which usually has lower rates but puts your home at risk; see home equity loan vs. HELOC.
Credit effects
Applying creates a hard inquiry. Paying off cards with a loan can lower your credit utilization, which may help scores, as long as the cards stay paid down; see credit utilization. Closing the paid-off cards reduces available credit and can raise utilization later.
Be wary of debt relief pitches
Legitimate consolidation loans come from banks, credit unions, and licensed lenders. Be cautious of companies that charge large upfront fees, guarantee to settle debts for pennies on the dollar, or tell you to stop paying creditors. Debt settlement is different from consolidation and can seriously damage credit.
The takeaway
A consolidation loan can save thousands when its APR, including fees, is clearly below your current rates and you stop adding new debt. Compare offers by APR, keep the term no longer than you need, and make a plan for the cards you've paid off.
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