Is debt consolidation a good idea?

What is debt consolidation?

Debt consolidation means combining several debts into one single payment, usually through a new loan or credit card. The aim is to make the debts easier to manage, and possibly reduce, your monthly payments.

Despite the lower payments, you could find yourself paying more overall due to interest. This might happen if the length of your consolidation runs for longer than the debts being combined.

Does debt consolidation affect my credit score?

Debt consolidation can affect your credit score in different ways. Understanding these effects can help you decide what's right for you.

Most people see their credit score improve over time after consolidation, as long as they stick to their payment plan and don't take on new debt. However, missing payments can have a negative impact.

How can I consolidate debt?

You have a few options for consolidating debt. Each method works differently and suits different situations.

• Personal loans are the most common way to consolidate debt. You borrow a lump sum and use it to pay off your existing debts. Personal loans often have lower interest rates than credit cards, especially if you have good credit.
• Secured loans can be ideal for consolidating larger debts. You will need to provide collateral to the lender, usually your home. As a result, you can borrow bigger amounts, usually at lower rates than other forms of borrowing. Importantly, if you miss payments, your home could be at risk, so you have to be confident you can afford them.
• Balance transfer credit cards let you move debt from multiple cards onto one new card. Many offer 0% interest for an introductory period, which can save you money if you pay off the debt quickly.
• Remortgaging allows homeowners to borrow against their property's value. You can often get lower interest rates this way, but you're putting your home at risk if you can't make payments.

Before choosing any option, compare interest rates, fees, and terms carefully. Consider speaking with a financial adviser who can help you find the best solution for your situation.

Is debt consolidation worth it?

A debt consolidation loan can be a great tool, but it's not right for everyone. Whether it makes sense depends on your own situation.

Benefits of debt consolidation

Debt consolidation offers several advantages that can improve your financial situation and reduce stress.

• Simpler finances (managing just one payment) is often the biggest benefit.
• Potential cost savings make consolidation attractive for many people.
• Fixed payment schedules can help you budget better.
• Your credit score can improve when you pay your consolidation loan on time, every time.

Drawbacks of debt consolidation

While debt consolidation can be helpful, it's important to understand the possible downsides before making a decision.

• Risk of increased debt is the biggest concern.
• Potential higher costs if you don't qualify for a good interest rate.
• Longer repayment terms might reduce your monthly payment but increase the total amount you pay.
• Potential early repayment charges on any loans you’re consolidating and paying off.
• Secured loan risks apply if you use a homeowner loan for consolidation. Your property becomes security for the debt, which means you could lose your home if you can't make payments.

Alternatives to debt consolidation

Debt consolidation isn't the only way to manage multiple debts. Several alternatives might work better for your situation.

• Debt repayment methods (like the debt avalanche and snowball methods) can improve how quickly you clear your debt.
• Debt management plans involve working with a debt charity or management company to negotiate with creditors.
• Individual Voluntary Arrangements (IVAs) are agreements with creditors to pay back what you can afford over six years. After this period, remaining debt is written off.
• Debt relief orders (DRO) help people in England and Wales who can't pay their debts. They freeze what you owe for one year, then wipe most debts away completely if your situation hasn't improved after this time.
• Bankruptcy is a last resort for people who cannot repay their debts. It provides legal protection from creditors but has serious long-term effects for your credit and assets.

Should I consolidate debt?

Deciding whether to consolidate debt depends on your personal circumstances. Consider these factors carefully before making a choice:

• Will you pay more or less interest? - Compare your existing rates to consolidation options to determine if you'll actually save money.
• Which type of debt consolidation loan is right for you? – Secured loans may offer better rates, but would require collateral. Personal loans do not need you to put anything up as security, but rates may be higher and amounts lower.   
• Will the loan cover all your debts? – Will you be able to borrow enough to cover the debts you want to consolidate?
• Will you be shortening or extending your loan term? – A longer term may mean lower monthly payments, but could cost you more in interest overall.
• Will a debt consolidation loan increase or lower your total cost? – Work out what it would cost to pay off your existing debts. Make sure you factor in any early repayment charges you may incur.
• Can you afford a debt consolidation loan? - Calculate the full amount you'll pay; while your monthly payments may be lower, longer terms may cost more in the long run.

Getting help with debt

If you're struggling with debt, remember that help is available.

Free debt advice can be found from these organisations:

• Citizens Advice provide free, confidential guidance on debt management options.
• National Debtline offer free telephone advice and online resources.
• StepChange provides online debt advice and can help you explore all your options.