Debt consolidation loans can help to simplify your personal finances. They can give you a better understanding of your debt and even reduce the interest you pay, however, debt consolidation loans aren’t for everyone and you need to take the time to consider whether it’s right for you.
What is a debt consolidation loan?
A debt consolidation loan doesn’t get rid of your debt, it moves it. It moves it from being in multiple accounts (i.e. credit cards and personal loans) to a single account.
For this to happen, you pay off (and maybe close) your old credit accounts with the credit from your debt consolidation loan. This way, you owe money to a single lender, meaning your debt is in one place. You have a single point of contact, one bill and it can reduce the total amount you end up repaying.
How can you get a loan to consolidate your debt?
You have to apply for the loan, as you would for almost all forms of credit. For the application to be successful you’ll have to meet your chosen lender’s requirements. To make a lending decision, the lender will use information from your credit report, your application and their own records.
By finding your loan through a service that can provide you with your eligibility before you apply, you can have confidence in your chances of being approved. If you have a low credit score, you may find it more difficult to get a good rate or to get approved for the loan. However, there are steps you can take to improve your credit score.
What to look out for when looking at debt consolidation loans
Total amount payable. While consolidating your debts can reduce the total amount you end up repaying, depending on the interest rate and duration of the loan this may not be the case. You need to compare it against your existing debt.
Fees. You may incur a charge to set-up your loan. Typically, it’s a set percentage of the amount you are borrowing. For instance, if you take out a loan for £2,500 and it has a 1% arrangement fee, you’d have to pay £25.
The effect on your credit score. Closing all of your establish credit accounts at once could have a negative effect on your credit score. Lenders look at multiple factors when calculating your score including the length of your credit history and the diversity of credit accounts.
Learn more about what affects your credit score!.
Bad credit and debt consolidation
Having a bad credit score doesn’t necessarily mean you won’t be accepted for a debt consolidation loan.
You can use secured and unsecured loans (personal loans) for debt consolidation. Typically, it’s easier to be approved for a secured loan because the lender uses an asset (your home) as collateral to reduce their risk. However, a secured loan is not to be taken lightly. If you don’t keep up with the repayments on a secured loan, you could lose the asset it has been secured against.
Debt consolidation - a good idea or not?
Consolidating your debt into one loan can have benefits:
A clear view. Having your debt consolidated can make it easier to see how much you owe, how quickly you’re repaying what you owe and the amount of interest you are being charged. Which may make you feel more in control.
Easier budgeting. You’ll only have one bill each month instead of several. It’ll typically be taken on the same day each month too and as you also have a clear view of your debt this can make it easier to budget each month.
Lower rates. Debt consolidation isn’t guaranteed to lower the amount of interest you pay. However, if you have, or do, consolidate your debt into one loan with lower interest, you can effectively reduce the total amount you end up re-paying.
Are there alternatives to a debt consolidation loan?
Balance transfer credit cards
If your debt is on credit cards, you could move it to a balance transfer credit card. This will serve to simplify your payments and if you take a card with a 0% deal you can also benefit from a 0% interest rate for the duration of the promotional period.
Keep in mind that:
You could be charged an initial fee to transfer the balance from your current credit cards to the new one
You will have a minimum repayment amount each month - ensure you pay at least that amount and on time each month.
The promotional period won’t last forever. Once the 0% period comes to an end you’ll typically be put onto the lender’s standard interest rate. You should aim to clear your debt before this happens to avoid paying interest.
Closing your old credit accounts can have a negative affect on your credit score.
Speaking with your lenders
If you’re looking to consolidate your debts because you are struggling with your repayments the first thing you should do is contact your lenders and discuss your options.
You should do this as soon as possible and be open and honest about your situation.
It’s more difficult for lenders to recover money once someone has defaulted, so they may be willing to make adjustments such as reducing your payments or waiving penalty fees. However, you need to be aware that this course of action will be marked on your credit report and can lower your credit score and it will take you longer to pay your debt if your repayment amount is reduced.
Seek advice from reputable sources
If you are struggling with your repayments reach out to a debt charity such as StepChange or National Debt Line. They’re reputable, non-profit organisations that are there to help you. They can give advice on ways to deal with debt.
Does debt consolidation affect your credit score?
If consolidating your debts means you’re able to make your repayments on time and in full each months this can have a positive effect on your credit score. This is because it shows a responsible pattern of behaviour in relation to your finances.
If your monthly repayments are lower because you’re paying less interest, this could mean you are able to make larger repayments and clear your debt quicker. This can also have a positive effect on your credit score.
Applying for any form of credit means a hard search will be added to your credit report. This can have a short-term negative effect by lowering your score. However, if you’re not making multiple applications in a short space of time your score should recover quite quickly.
As previously mentioned, closing old credit accounts can have a negative effect on your credit score. This is because lenders like to see that you have mature (well managed) accounts and because it could change your credit utilisation. Your credit utilisation is a calculation based on the amount of credit you have used and your overall credit limit. Typically, lenders like to see credit utilisation in the 10-30% range.
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