How does debt consolidation work?

What is the debt consolidation process?  

The debt consolidation process involves: 

1. calculating all your outstanding balances
2. researching which debt consolidation option is best for you
3. taking out a new line of credit to clear your debt
4. sticking to your repayment plan

1. Calculate your outstanding balances 

To consolidate your debt, you first need to calculate exactly how much you owe in total, including interest and potential early repayment fees. Contact your individual creditors and ask for the total amount you need to pay each one. They legally have to give this to you, so don’t worry about your request being denied. Then you can add the balances together.

You’ll need to get out a new form of credit that covers the total sum of your debts. For example, if you owe £1,500 on a credit card and £5,000 on a personal loan (including interest), you’d owe £6,500 in total – so you’d need to take out credit for £6,500.

It might be tempting to take out more money than you need to pay back, but remember, you’re trying to clear your debt. Borrowing a larger sum will put you into further debt.

2. Do your research  

Once you know the total amount of money you owe, you’ll need to research which credit options are available to you and suit your personal financial circumstances (such as your affordability).

You can use comparison websites to compare the best deals on the market without having to search individual providers. It’s a good idea to still check individual providers’ websites too, because not every company will be on comparison websites.

You can also use brokers (like Ocean) who can find the most suitable deal that you’re eligible for from their portfolio of lenders. They could find an option that suits your financial circumstances - and which might not be available on the high street.

Once you’ve found a product you’re interested in, you’ll want to check whether you’re eligible - before applying. This is because formally applying for any form of credit leaves a footprint on your credit history. Whereas you can check your eligibility without impacting your credit score.

You want to avoid making multiple applications because this can damage your credit score. So, we suggest you use an eligibility checker first, to see whether you’re likely to be accepted.

3. Combine debt into one payment  

The next step is to combine your debt into one payment using your new line of credit, such as a debt consolidation loan, a balance transfer credit card, or a personal loan, for example.

Any debt that falls under the Consumer Credit Act 1974 is eligible for early repayment, including:

• credit cards
• personal loans
• payday loans
• store cards
• store finance (e.g. ‘buy now pay later’)
• purchase hires

Note, secured loans are included under the Consumer Credit Act - but not if they’re secured against your main residence.

If you’re unsure whether your debt falls into one of these categories, check the terms and conditions – this information should be in there.

Remember, if you consolidate your existing borrowing, you may be extending the term and increasing the amount you repay in total.

4. Pay on time, every time

The final step to consolidating your debt is keeping up with your new repayment plan.

Paying the agreed amount on time each month is crucial to clearing your debt. It also increases you credit score and shows lenders that you can be trusted to make repayments.

If you stop making repayments the lender can chase you for the money owed, or even take legal action against you (usually as a last resort). Missed payments will show up on your credit history for six years and cause your credit score to decrease. Also, you could be charged late fees, leading you to slide further into debt.

If you’re worried about being able to make your repayments, contact Citizen’s Advice for help or speak to a free debt charity like StepChange.

What is the best way to consolidate debt into one payment?

The best way to consolidate debt into one payment depends on your personal financial circumstances. You may want to consider one big loan to pay off debts like a debt consolidation loan, or you may prefer a balance transfer credit card for smaller balances.

There are a number of factors to take into account, including (but not limited to):

• your eligibility and affordability
• the lender’s criteria (which varies from one lender to the next)
• how much you need to borrow to clear your debts in full (for example, you can usually borrow more on loans than credit cards)
• the cost of borrowing (e.g. interest rates which tend to be higher across all forms of borrowing if you have a low credit score)
• the types of debt you want to consolidate

For instance, you can use a loan to consolidate all the above-mentioned types of debt under the Consumer Credit Act - but you can only use a balance transfer credit card to clear credit card debt.

1. Debt consolidation loan 

• specifically designed for debt consolidation purposes, it can be used to clear all types of debts from loans to credit cards to overdrafts
• you take out a lump sum to clear your debts in full, then make one monthly repayment to one lender until the loan is paid in full
• can be secured (tied to an asset) or unsecured (not tied to an asset)
• secured loans tend to be for higher amounts and more competitive interest rates – but if you fall behind with repayments, you could risk losing your property

2. Balance transfer credit card

• allows you to pay off existing credit cards with a new line of credit
• some deals include an interest-free period for balance transfers which could save you money if you clear your balance before the offer ends and interest becomes applicable
• credit card providers normally charge fees for balance transfers, so make sure you find out how much this will cost
• not all credit card providers allow balance transfers – you’ll need to research this thoroughly before you decide on a credit card

3. Personal loan to consolidate credit card debt 

• like a debt consolidation loan, you can use a personal loan to consolidate different types of debt
• a personal loan is unsecured, so you don’t secure it against anything you own, like a house or car. This means that you won’t have to worry about losing your home if you can’t afford to make the repayments
• the lender can still take legal action against you if you stop making repayments. You should ensure you can afford the repayments before you take the loan out
• as personal loans are unsecured, you might be offered a higher interest rate than you would with a secured loan