If you’re paying off a number of different debts, debt consolidation is one option available to you that can make it far easier to manage your finances. With a debt consolidation loan, all debt repayments up to £25,000 can be combined into a single monthly payment, typically over a period of between 1 and 5 years (with some providers offering a repayment period of up to 25 years).
However, there are various different types of debt consolidation loans out there and, depending on your personal circumstances, it may or may not be the right choice for you.
This fuss-free guide offers insight on what debt consolidation loans are, who they’re suited to and the small print that goes alongside them, so that you can make an informed decision when it comes to managing your personal finances.
What is a debt consolidation loan?
A debt consolidation loan is used to combine some, or all, of your different debts into one, manageable, monthly payment over an agreed period of time, and is paid straight to your other lenders.
Under the right circumstances, consolidating a number of smaller debts into one loan payment can be an effective long-term solution, as this makes it easier to monitor loan repayment outgoings, and can significantly reduce the amount of interest you pay back each month – helping you to take back control of your finances.
The APR interest rate that you’ll be charged will depend on your own personal circumstances, but can generally fall anywhere between around 3% and 100% – so this is worth bearing in mind before you start searching for your lender.
In 2017, the average UK debt per person (excluding mortgages) was £8,000. Now, if you were to borrow £8,000 over a period of 3 years in order to consolidate your debt at a rate of 3.7% APR and an annual fixed interest rate of 3.7%, you’d end up paying a monthly amount of £234.91. As a result, over the 3-year period, you’d pay back a credit charge of £456.76 – making for a total repayable amount of £8,456.76 over the 36 months.
Types of debt consolidation loan:
It’s important to be aware of the two basic types of consolidation loan available on the market – secured and unsecured:
- Secured debt consolidation loans are typically given to individuals looking to borrow a large amount of money, or for those with low credit ratings. These types of loans are secured against one of your valuable assets – typically your home or car – and if you’re unable to repay the loan, they become at risk of repossession
- Unsecured debt consolidation loans aren’t secured against personal assets and are usually offered to individuals borrowing smaller amounts, or those deemed low-risk in terms of missing payments. The most common types of unsecured loan are personal loans, credit card loans and personal loans
Do you fit the criteria?
According to a report by Money Advice Service, in 2017, 1 in 6 adults in the UK were found to be over-indebted – with larger families, young adults, parents and those living in rented accommodation deemed the most vulnerable to debt.
When applying for a debt consolidation loan, there are certain criteria you’ll need to meet for lenders to seriously consider your application:
- You must be permanently living in the UK
- You must be aged 21 or over, with a regular gross income of at least £6,000
- You must have a good, traceable credit score and not have been declared bankrupt or had a County Court judgment (CJJ) within 6 years prior to taking out the loan
Debt consolidation isn’t necessarily the best solution for everyone, so, before you consider applying, it’s recommended that you seek professional financial advice and consider all of your options.
When contemplating a consolidation loan, always have in mind that you’ll need to be able to comfortably afford the monthly repayments – even if your situation changes. Falling ill, losing your job or rising interest rates could all cause you to fall behind on payments or default on the loan altogether, which may put assets at risk if you have a secured loan, and negatively affect your credit score.
Another thing worth checking before you consider this type of loan is whether you’ll incur any penalties from your original bank or lender for paying back the full amount earlier than originally agreed (otherwise known as a resettlement).
It’s also important to take into account whether consolidating your loan outgoings into one payment will actually mean savings for you. It should not only reduce monthly payments, but also allow for the cost of additional fees and charges for arranging the loan itself and any early repayment fees on existing debt.
In addition, it’s essential that this solution helps you to become debt-free in the long term, and that the payments aren’t so high that you have to dip back into borrowing to make ends meet. It also goes without saying that the amount borrowed should cover all of your debts, and that the overall amount payable isn’t more than you can afford to comfortably pay back – otherwise you may find yourself in a similar situation further down the line.
Benefits of debt consolidation loans
Combining all (or some) of your credit card payments, store cards and loans into one manageable sum does offer borrowers some benefits, which include:
- Lower monthly payments – With many borrowers only able to afford the ‘minimum payment’, this can mean they’re not actually chipping away at the loan, but instead simply paying off the loan interest. However, switching to a debt consolidation loan that offers a different loan term can mean you receive better repayment terms, with lower monthly amounts that actually contribute to paying off both the debt and interest
- Reduced interest rates – If you have outstanding store cards and credits cards, the interest rates applied can be considerably higher than that of a consolidation loan, so there may be savings to made
- Improved credit rating – If you’re looking to boost your credit rating, successfully repaying and maintaining a debt-free record can go some way towards improving your credit score, should you wish to apply for a different type of loan or credit card in the future
Risks to be aware of
Understandably, taking out any kind of loan comes with an element of risk, and debt consolidation loans are no different. However, the levels of risk will vary depending on your personal situation:
- Higher risks for those with a bad credit rating – In many cases where individuals are deemed as having a bad credit rating, they will only be eligible for a secured loan. Should your circumstances change and result in you defaulting on your loan agreement, these assets may be repossessed by the lender
- In debt for longer – Borrowing a large amount of capital to pay off a myriad of debts can be an effective way to secure a more attractive interest rate and reduce your loan outgoings each month – but this may also mean you’re in debt for longer. Before committing, be sure you’re completely happy with the agreed term and take the time to read the small print – looking out for additional charges for early repayment, or one-off contributions that can further reduce the amount owed
- Risk of not being accepted – Being in debt can feel like a desperate situation, and the need to find a quick solution may appear to be applying for as many loans as possible, but this can, in fact, hinder your chances of having an application accepted. Applying for too many loans over a short period of time can negatively impact your credit score, indicating to lenders that you may be struggling financially – so shop around first and thoroughly assess your options before submitting a loan application
Steps to take to find the right loan for you
Once you’ve considered both the benefits and risks and decided whether this type of loan suits you and your personal circumstances, you’ll be able to begin your search for the most appropriate lender, following the steps below:
- Figure out the total amount you need to borrow – Add up all the debts that you’d like to consolidate, remembering to include additional charges such as resettlement costs, and the overall amount will inform the figure you apply to borrow
- Work out how long you’ll need to pay it back – Remember that, while a longer repayment period means lower monthly repayments, you’ll be paying back more overall through ongoing interest charges
- Research interest rates – Make sure you do your research and look out for the lowest APR rates on the market. Be careful, though, as lenders are only required to give 51% of borrowers the advertised interest rates – so it’s important to clarify exactly what rate you’ll be entitled to before choosing to move forward with your loan
If you’re struggling to cope with your existing debt, a debt consolidation loan could be a suitable option. However, there are plenty of alternative options for paying off your debt such as administration orders, debt management plans, debt relief orders and individual voluntary arrangements – so make sure you understand all of these before going ahead with your application.
And don’t forget to visit our blog, where you’ll find personal finance tips, loan guides and other resources to help you make an informed decision and take a confident step towards becoming debt-free.
For help and advice regarding managing your personal finances, we recommend visiting the Citizens Advice website here, or calling the free national debt helpline at 0808 808 4000.