Debt Consolidation Loans
Debt consolidation loans are designed to simplify and reduce the total repayment cost of your existing unsecured debts.
What is a debt consolidation loan?
As you acquire a greater number and wider variety of debts it can become more and more difficult to manage them and stay in control of the repayments.
If you’ve got outstanding personal debts including unsecured loans, credit cards, overdrafts and store cards then you might want to consider a loan to merge them into a single monthly payment.
These so-called “debt consolidation loans” could either be a single larger unsecured loan or, if the debts are much greater and you own your home, a secured loan or even a mortgage/remortgage.
Debts to consolidate
These are examples of debts you can consolidate:
- Credit cards
- Store cards
- Bank overdrafts
- Personal Loans
- Lines of credit
- Medical, Utility & Phone bills
Generally, you cannot consolidate mortgages or other loans secured against property or other assets.
How debt consolidation can help you
Debt consolidation aims to help in two ways by:
- Reducing the monthly debt repayment to an affordable amount
- Simplifying the structure of the debt to make it easier to control
The example below shows how this is done. The person has a range of existing unsecured debts. Each has a different rate of interest, monthly repayment date and repayment term. Meanwhile, their income arrives on a particular day in the month. They are beginning to struggle to manage their payments, for two reasons:
- managing their monthly budget from day to day is difficult given the timings of their income and various payments
- the total of all their payments on top of their routine spending is beginning to outstrip their income.
They are becoming uncertain about which payments they can afford to make and when. Debt is dragging them down. You may be familiar with this feeling.
The person decides to consolidate their debts. They want to reduce their monthly payment, and they want to simplify their repayment. Now they have a single payment that’s also lower than they were paying before so making the debt repayment more affordable.
Remember! Debt consolidation doesn’t reduce the overall amount that you owe. It only aims to cut your interest costs and simplify the management of your debt. After you have consolidated your debt do not add new debt – stop using your credit card, don’t drift into your overdraft facility, etc.
When restructuring your debt like this you want to not only reduce your monthly payment, but also the total amount of interest you will have repaid by the end. Be careful about extending the repayment period as this will either reduce the savings you can make or worse could increase your total interest costs.
Compare debt consolidation loans
The ONS in its Wealth & Assets survey estimates that UK households typically have unsecured debts of around £5,000. However, the average of all households is £9,400 indicating that there are many households that owe considerably more than £5,000. There are a number of ways to consolidate this debt. The ones available to you will depend on the size of your debt and if own your home.
How to consolidate your debts
Before you apply for a debt consolidation loan you need to be clear what debt you are going to consolidate and what your it is currently costing you. It’s also worth getting hold of your credit file and implementing any quick fixes available to you. Then start the process of comparing consolidation loan options and ensuring they make financial sense.
1: List your Current Debts
Make a list of all your personal debts - the amount, the monthly cost and how many months of payments are left.
4: Apply for & Get your Loan
Depending on the type of loan you opt for it could take anything from a few days to a few weeks to be paid out. You will start benefitting soon!
Consolidation with a secured loan
Using the illustration above here is how a new secured loan could consolidate existing unsecured debts to help reduce a person’s debt repayments:
Assume an existing unsecured debt of £10,000 comprising:
- £7,500 on a credit card – interest rate 17.9% APR
- £2,000 on a bank overdraft – interest rate 18.9% APR plus a £20 monthly fee
- £500 short-term loan – interest rate 68.8% APR.
Total monthly repayments on this debt are £435. Total interest repaid by the end of the repayment term is £4,145.
Consolidated debt (secured loan)
The person takes out a secured loan for £10,000 at a rate of 12.5% APR (much lower rates are currently available). This loan is used to pay off the more expensive debt above.
The total monthly payment is reduced to £335 compared to £435 before.
The person also halves the total amount of interest they need to repay, assuming a reasonable 3 year repayment period.
Warning: A secured loan means it is secured against the home that you own. If you use a secured loan to consolidate your unsecured debts your home may be repossessed if you fail to keep up loan repayments. Also, it is possible that while reducing the monthly payment you may end up paying more overall if you extend your loan too far.
Alternatively, these unsecured debts could be consolidated using a new personal loan. This would avoid any property risk, but the interest rate would most likely be higher. Secured loans are only available to homeowners.
Guide to Managing Debt
If you’re uncertain which type of credit might suit you or you have a money problem then one of guides may help you. We summarise each type of loan and their pros and cons, and address issues regarding debt and credit ratings.
Got a Question about Debt Consolidation?
Answers to Common Questions
Debt consolidation is a way to merge some or all of your personal debts into a new, single, lower-cost monthly payment. It also makes the management of your debt easier.
What is “Consolidation”?
The dictionary definition of “consolidation” is:
“to combine (a number of things) into a single more effective or coherent whole”
In the case of loans this means:
- pulling together a number of loans into one larger loan (i.e. “single”)
- reducing the overall cost of servicing and paying off the debt (i.e. “effective”)
- reducing the overall stress on the borrower and making both financial and human sense (i.e. “coherent”)
You can consolidate unsecured debts such as credit cards, store cards, overdrafts, personal loans (inc. payday loans, instalment loans), lines of credit and even some types of bill (e.g. utility and phone). You cannot consolidate loans that are secured on an asset, such as a mortgage.
Over time you may accumulate a variety of unsecured debts such as credit cards, short term loans, etc. As this happens it may become progressively more difficult to manage the debts and perhaps even afford the repayments. The process of consolidation is about paying this existing debt off with a new one where the aim is not only to simplify the administration but also reduce the overall costs.
The process for getting a debt consolidation is described here, but in essence, it requires you to know in detail what debt you have and what it is costing you. You have to choose which type of loan suits your circumstances and meets your affordability objectives.
Debt consolidation loans do work if you plan them properly. If you have then you can achieve lower repayments without pushing the repayment term too far into the future. You must ensure you meet the repayment terms of the new loan which is all the more important if you have opted to use a secured loan.
Although you can choose to consolidate your debt at any time it is really only a good idea if:
- you reduce your monthly payments (to make your debt more affordable each month) and the total interest you pay by the end is less than would otherwise have been the case
- these savings aren’t swallowed up by any fees or charges you might incur as you consolidate
- you simultaneously cut your spending and don’t grow your debt further.
If you can’t reduce your spending and you racking up new debt then you have problems that debt consolidation cannot solve. In this case, you should get free debt advice. See our blog for other articles about debt.
Debt consolidation is a bad idea if:
- your new loan payments are unaffordable
- the new loan isn’t large enough to clear your other more expensive debt
- you choose to extend the repayment period of the new loan and end up paying more interest overall
- your debt problem is more fundamental and you need proper debt advice
- you use a secured loan to do debt consolidation and you put your home at risk knowing the payments are going to be a challenge.
There isn’t a specific loan called a “debt consolidation loan” but there are various types of loan that can be used to consolidate more expensive debt into one that is cheaper overall. These are either secured or unsecured loans. We’ve listed the main options here.
Debt consolidation is about improving your ability to repay your debts so if you choose your loan wisely you should be able to enhance your credit rating in the long run. Using a new, lower-cost loan to pay off more expensive debt is actually sound financial planning – just don’t expose yourself to additional risks, especially if you elect to use a secured loan as your way to debt consolidation.
If you have had credit problems and your rating is not perfect you should still be able to find a new loan to consolidate your existing debt. Do keep in mind that the rate will be higher than for someone with good credit, and you will need to make sure that your new loan will indeed save you money overall. If you believe your debt situation is more fundamental then we would urge you to get free debt advice before committing to debt consolidation. You may find a debt advisor can suggest other ways to alleviate the problem you have.
IF YOU ARE THINKING OF CONSOLIDATING EXISTING BORROWING YOU SHOULD BE AWARE THAT YOU MAY BE EXTENDING THE TERMS OF THE DEBT AND INCREASING THE TOTAL AMOUNT YOU REPAY. MISSING PAYMENTS ON A LOAN WILL HAVE SEVERE CONSEQUENCES AND MAY MAKE OBTAINING CREDIT MORE DIFFICULT IN THE FUTURE.
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