Debt consolidation loans
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What is debt consolidation?
Debt consolidation combines multiple debts into a single loan. Instead of managing several credit cards, personal loans, and other debts with different interest rates and terms, you take out a new loan that pays everything off.
This leaves you with just one monthly payment to make, which is often at a lower interest rate than your existing debts.
The goal is to simplify your finances, reduce and manage your repayments, and potentially pay off your debts more quickly.
Types of debt consolidation
Debt consolidation comes in various forms. Here's an overview of the most popular types:
Secured debt consolidation loan
A secured loan requires you to put up collateral, usually your home, as security. Because of this safety net for the lender, secured loans tend to have lower interest rates than unsecured loans. But if you fall behind on your payments, you risk losing your home.
Get your quoteUnsecured debt consolidation loan
Unsecured loans don't require collateral, which makes them less risky for the borrower. But they tend to have higher interest rates than secured loans, and maximum loan amounts are often lower. You'll also typically need a good credit score to access the best rates.
Get your quoteDebt management plan (DMP)
A DMP is an arrangement where you make a single monthly payment to a third-party company, who then pays your creditors. While it's not technically a loan, a DMP consolidates debt and simplifies your payments. It can also help you avoid further damage to your credit score.
Get your quoteBalance transfer credit card
This involves transferring your existing credit card debts to a new card with a low or 0% interest rate for a promotional period. Balance transfers can be an effective way to manage credit card debt, but they're not suitable for larger or non-credit card debts.
Get your quoteRemortgaging
This involves taking out a new mortgage to release equity and pay off your debts. The new mortgage may have a lower interest rate, but it's important to consider the potential risks, such as extending the length of your mortgage and increasing your monthly payments.
Get your quoteHome equity loan
If you own your home, a home equity loan allows you to borrow against the value of your property to pay off your debts. This is a secured loan, so while it can offer lower interest rates, it also comes with the risk of losing your home if you fall behind.
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Debt consolidation vs. credit card balance transfer
The balance transfer option depends on the size of your debt, and whether you can pay it off during the 0% interest period.
Debt consolidation loan
A debt consolidation loan can either be secured or unsecured, but it should simplify your finances and combine your debts into one. The loan often comes with lower interest rates, particularly if you have a good credit score, but it can be high if not. A loan may suit larger debts, but it doesn't guarantee your monthly outgoings will be drastically reduced.
Credit card balance transfer
This allows you to move existing borrowing from one or more cards to a new one, often with a 0% interest rate for a set period. This can be attractive if you can pay off the balance before it ends, otherwise the interest rate can jump significantly. This is more manageable with smaller debts, and you must avoid adding new debt to the card and undoing the benefits.
Pros and cons of debt consolidation
Advantages
- Lower interest: Debt consolidation loans may offer lower interest than credit cards or payday loans.
- Single monthly payment: One payment each month, to one creditor, makes budgeting easier and reduces stress.
- Improved credit score: Consolidating your debts and making regular payments could improve your credit score over time.
- Fixed repayment term: You know exactly when your debt will be paid off, giving you a clear path to debt freedom.
Disadvantages
- Higher total cost: If you extend the repayment period, you might pay more in interest over the life of the loan.
- Risk of more debt: Consolidation loans may not address the root cause of your debt, and you could accumulate more.
- Repossession risk: If you opt for a secured loan, you risk losing your home if you don't repay.
- Bad credit issues: If you have bad credit, you may not qualify for a loan with favourable terms, making consolidation harder.
Should I take out a debt consolidation loan?
Debt consolidation can be a great idea if you’re struggling with multiple debts and need a way to simply them. If you're confident that consolidating will lower your monthly payments and interest rates, it can offer great relief and help you get back on track. But it’s important to be cautious. Consolidation won't solve the root cause of your financial problems and you may find yourself in the same situation down the road. Carefully assess your habits, your amount of debt, and whether you can commit to making the payments.
Fees and costs with debt consolidation
1. Origination fees
Lenders may charge an origination fee for processing the loan, typically between 1% and 5% of the loan amount.
2. Interest rates
The interest rate on a debt consolidation loan is often the biggest cost. It can vary depending on your credit score, the loan type, and the lender, with rates ranging from around 5% to 35% or more.
3. Late payment fees
If you miss a payment on your loan, you may be charged a late fee, usually a flat fee or a percentage of the missed payment. With a secured loan, you also risk losing your home if you fall behind.
4. Early repayment fees
Some lenders charge fees for paying off the loan early. These penalties are designed to compensate the lender for the lost interest.
5. Monthly service fees
Some debt consolidation loans may include monthly service fees, particularly if the loan is part of a debt management program or if the lender offers additional admin services.
6. Closing costs
In some cases, lenders may charge closing costs, including document preparation fees, appraisal fees (for secured loans), and other processing charges.
Our expert says:
‘’If you're juggling credit cards, personal loans, or even student debt, there are several consolidation options out there, each with its pros and cons. Assess your finances carefully and consult with a professional where possible. If done correctly, consolidation can give you back control of your money and help you on the road to debt freedom.”
Frequently Asked Questions
Is debt consolidation right for me?
Debt consolidation can be a viable option for people struggling with multiple debts. It can help simplify your finances by turning several payments into one, often at a lower interest rate.
It's important to assess your financial situation before deciding if consolidation is right for you. You should ensure that the total cost of the new loan is lower than continuing with multiple, higher-interest debts.
Work out how much you owe and the interest you're paying for each debt, how much you're currently paying off each month, and the end date. If your debts are relatively small and manageable, consolidation might not be necessary.
Be realistic about whether you can avoid accumulating more debt once you've taken out the new loan. If you have a tendency to take on new credit after consolidating, you may end up in the same situation again.
Ideally, debt consolidation lets you regain control of your finances. But if you are worried that you may still struggle with repayments after consolidating, or may need to start borrowing again, it's important to seek specialist advice.
What kinds of debt can I consolidate?
It's possible to consolidate credit card balances, personal loans, overdrafts, store cards, overdue utility bills, payday loans, and more.
It’s important to note that student loan consolidation isn't quite the same as consolidating other types of personal debt. They're typically managed by the Student Loan Centre (SLC), who have their own consolidation scheme for borrowers who have more than one student loan.
They may also offer provisions to write off student debt after a certain period or if you become permanently unfit to work.
Consolidation generally isn't recommended for paying arrears of rent or mortgage payments. Rent isn't considered a type of debt, and paying your mortgage with a loan may land you in more debt with higher interest than you started with.
It's worth researching or seeking advice from a financial advisor or a debt counselling service to understand your options in regards the various kinds of debt. If you're having trouble with your monthly mortgage payments, it's vital to talk to your provider as early as possible.
Will debt consolidation affect my credit score?
Debt consolidation can affect your credit score in positive and negative ways, depending on how you manage your new payment plan.
Initially, applying for a debt consolidation loan may cause a temporary dip in your credit score due to the checks involved. Lenders will look at your credit history to assess the risk, and a hard inquiry on your credit report can slightly reduce your score.
If you successfully consolidate your debts and make consistent, on-time payments on the new loan, your credit score could improve over time. Reducing your number of credit accounts and payments lowers the likelihood of missing payments and negatively impacting your score.
Additionally, if your consolidation loan comes with a lower interest rate than your previous debts, you may be able to pay off your debt more quickly, which in turn has a positive impact on your score.
Can I consolidate debt with bad credit?
Yes, it's possible to consolidate debt with bad credit, but your options may be more limited and come with higher interest rates. But there are still ways to consolidate debt.
One option is to apply for a secured loan, where you use assets like your home as collateral. Lenders may be more willing to offer a loan to people with bad credit if they have security, because it reduces their risk. The main downside is that if you fail to repay the loan, you could lose your home.
You should carefully consider your options and avoid taking out any form of consolidation if you're unsure about your ability to repay it. Consulting with a financial advisor or credit counsellor can help you make the best decision for your finances.
How long does it take to consolidate debt?
The time it takes to consolidate debt depends on the method you choose. Personal loans and balance transfers can typically be arranged fairly quickly, often within a few days or weeks, depending on the lender and your financial situation.
Once the loan is approved, the process can be immediate - your loan provider will pay off your existing creditors and you’ll be left with a single loan to repay.
Debt management plans (DMPs), on the other hand, can take longer to set up. DMPs are typically arranged through a debt management company, and the process of negotiating with your creditors may take several weeks. DMPs can also take years to fully pay off, depending on the size of your debts.
Secured loans can also take time to arrange. They often require an appraisal of your property or asset to determine its value, which can take a few weeks. The approval process may also take longer if your credit score is lower.
Regardless of the consolidation method you choose, the key is to take action quickly. Delaying the consolidation process can lead to missed payments, additional fees, and worsening debt. Be sure to shop around for the best options and understand how long the process will take before committing to a solution.
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