What is debt consolidation?
Debt consolidation is when you combine all your debts into one single debt. This means you take all your loans, credit cards, overdrafts, etc and consolidate them into one single monthly repayment – usually a new loan that covers the total amount of debt you owe.
For example, if you owed £10,000 on a loan, £5,000 on a credit card and £1,500 on an overdraft you could combine these into a single loan for £16,500.
What happens when you consolidate your debt?
Usually people take out a debt consolidation loan or a balance transfer credit card that covers the total amount they owe across various debts. They use the credit lent to them to pay off the rest of their debts early, leaving them with one single loan to make repayments on. In some cases, it helps people reduce the amount of interest they need to pay.
You can consolidate any debts that can be repaid early under the Consumer Credit Act. These include:
- most types of loans, including secured, unsecured and payday loans
- credit cards
- overdrafts on current accounts
- old outstanding utility bills (not current bills)
- unpaid tax
- any debt that’s been passed onto a debt collection agency or a bailiff
What are the pros and cons of debt consolidation?
Normally people consolidate their debt to make it easier to manage their repayments and to have one monthly payment go out instead of several. But you’ll need to work out whether it’s the best financial decision for you by weighing up the pros and cons.
- you only owe money to one lender - it might be simpler for you to keep track of how much you owe if you only owe money to one lender. You might find this less stressful than owing to multiple companies at one time
- you have a single monthly repayment to make - you might find it easier to manage one monthly repayment instead of several different ones that go out at different times each month. This could help you avoid missing repayments
- you could save money on interest - the different interest rates on your various repayment agreements could add up to a considerable amount. Consolidating your debt may reduce the amount of interest you have to pay overall
- you could reduce your monthly repayments - if you’re struggling to make all of your monthly repayments consolidating your debt could give you space to reduce them into a manageable monthly amount
- you may not be eligible - if you have a poor or thin credit history, you might not get accepted for a debt consolidation product that allows you to save money on interest and/or reduce your monthly repayments. To avoid making multiple credit applications and damaging your credit score further use an eligibility checker to see whether you’re likely to be accepted for a product before you apply.
- you may have to pay fees - it’s common practice for credit card providers to charge you for balance transfers and it’s possible that there will be hidden fees in taking out a debt consolidation loan. Make sure you you’re aware of the fees before applying for any type of credit
- you may be charged higher interest if you have bad credit - taking out a loan or credit card with a high interest rate to consolidate your debt could mean that you end up paying more on interest overall
- it may take longer to pay off your debt - if you consolidate your debt into a single monthly repayment that’s lower than the amount you were paying on all of your debts per month before, it may take longer for you to pay off your debt, which can increase the amount you repay in total
Factors to consider before taking out a debt consolidation loan
Taking out a debt consolidation loan is a big financial decision, and you should consider these five factors before applying:
1. Can you afford a debt consolidation loan?
A debt consolidation loan will require you to pay back a certain amount each month. Make sure you can afford the repayments (including interest and fees) before applying. Otherwise, you may find yourself sliding further into debt.
2. Will the loan cover all your debts?
You’ll need to take out a loan that covers all of your other debts. If it doesn’t, you’ll just be adding to your debt by taking out another loan instead of consolidating it.
Add up the amount of debt you owe and only look at debt consolidation options which cover that amount.
3. Will you be shortening or extending your loan term?
Extending your loan term is likely to cost you more overall. You want to be debt free as soon as possible so make sure your repayments are reasonable in comparison to your income and necessary expenses.
4. Will you pay more or less on interest?
A key incentive for debt consolidation is to pay less interest. However, people with a thin or poor credit history might only be eligible for loans with high interest rates. Consolidating your debt into a loan with a higher interest rate than what you pay at the moment may put you further into debt.
5. Will a debt consolidation loan increase or lower your total cost?
Work out the total cost of all of the debts you currently have including interest and fees. If you’re unsure what these are you can request them from your lenders.
Can I get independent advice about debt consolidation loans?
You can get free, confidential advice about debt consolidation loans and about debt in general from StepChange, a UK debt charity. You can also make an appointment with your local Citizen’s Advice to discuss your options for clearing your debt.
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Intelligent Lending Ltd is credit broker, working with a panel of lenders. Homeowner loans are secured against your home.