What is debt consolidation?

It's all too easy to let one missed loan payment or an overdue credit card bill balloon into out-of-control debt.

One solution is to use a personal loan through companies like SoFi, LightStream or Happy Money to consolidate your credit card debt into one monthly payment. This usually results in lower interest and can help you interrupt the debt cycle for good.

Below, CNBC Select explains what debt consolidation is, how it works and why it can save you money in the long run.

If you have outstanding debt on more than one credit card, you can apply for a debt consolidation loan. You use this loan to pay off your credit card debt, then repay the loan in monthly installments, usually with a lower interest rate than you were paying on your credit cards. Typically, personal loans are fixed-rate, meaning the APR is locked in for the lifetime of the loan, and you pay the same monthly amount until it's paid off. This is an advantage over credit cards, which have variable APRs that can go up and down.

You can get a loan through a traditional lender, like a bank, or from an online peer-to-peer lending company like SoFi or LendingClub. Banks tend to have traditional standards consumers must meet to get approved for a loan, meaning you will need to have a qualifying credit score, significant borrowing history with documented on-time payments and a high enough debt-to-income ratio that proves you have the resources to afford the monthly payment. On the other hand, peer-to-peer lenders have slightly more relaxed or non-traditional requirements. For example, Upstart looks at your level of education and job history in addition to your credit score.

Debt consolidation loans are similar to a balance transfer card with a 0% APR period, but they work a little differently. To begin with, balance transfers typically charge fees between 2% and 5%, unless you opt for a no-fee balance transfer card. The Citi Double Cash® Card, for example, has an intro balance transfer fee of 3% of each transfer (minimum $5) completed within the first four months of account opening. After that, your fee will be 5% of each transfer (minimum $5; see rates and fees). The card requires good to excellent credit to qualify, whereas there are a variety of personal loan options for people with fair credit and good credit.

Unlike a balance transfer, where you move debt from one account to another, when you get a consolidation loan, the cash is deposited directly into your bank account that you can use to pay off all of your credit card debt at once. Then, you pay back your lender with monthly payments over a timeline that is determined when you apply for the loan. Once a personal loan is paid off, the credit line is closed and you have no more access to it. 

Like any loan, you'll be charged interest, but the APR for a personal loan is usually lower than what a credit card would charge. Typically, your interest payments are calculated into your monthly payment and divided over the lifetime of the loan. Most loan terms range anywhere from six months to seven years. The longer the term, the lower your monthly payments will be. However, you'll be charged more interest over time so it's best to choose the shortest term loan you can afford.

In addition, some lenders charge a sign-up, or origination, fee. However, there are several no-fee options with varying interest rates depending on your credit score. You should opt for a no-fee personal loan whenever possible.

Debt consolidation loans are great if you have multiple credit card balances. Merging those balances into one personal debt consolidation loan is a helpful way to streamline your bill payments, since you'll only have one account to keep up with.

While debt-consolidation loans make budgeting easier, the most important factor to consider when opening one is the interest rate. 

For example, say you have $10,000 worth of credit card debt with a 22% APR. If you paid it off in three years (and assuming you always make at least the minimum payment and don't incur late fees), you would pay a total of $3,748.56, in interest, according to Experian's APR calculator. Meanwhile, if you took out a personal loan with 13% APR, you would pay $2,129.82 in interest. This is a potential savings of $1,618.74.

Before applying for any kind of personal loan, you should see what APR you prequalify for using the loan company's website. This can usually be done by inputting your social security number, date of birth, annual income, employment status and contact information.

While it's not a guarantee, this will give you an idea of what rates you qualify for. If the lender offers you the same APR, or a higher rate, on the loan as your credit cards, you should not consolidate.

Debt consolidation loans can help you streamline your budget by letting you pay off debt in one simple monthly payment. Moving your credit card debt over to a personal installment loan will also usually cause a noticeable jump in your credit score, since this effectively brings down your credit utilization rate. 

However, despite the convenience and simplicity of a consolidation loan, you should pay close attention to interest rates and fees as you inquire about preapproval. Ideally, you can find a loan that can both helps make your monthly payment more manageable while also saving you on interest in the long-run.

And like any credit product, be sure that you have a plan in place once your balance hits $0 to help you keep credit creep at bay.

At CNBC Select, our mission is to provide our readers with high-quality service journalism and comprehensive consumer advice so they can make informed decisions with their money. Every personal finance story is based on rigorous reporting by our team of expert writers and editors with extensive knowledge of these products. While CNBC Select earns a commission from affiliate partners on many offers and links, we create all our content without input from our commercial team or any outside third parties, and we pride ourselves on our journalistic standards and ethics.