Debt consolidation loans are one way of dealing with overwhelming debts. By taking out another loan to pay off a number of smaller debts, you may be able to reduce your monthly payments and simplify your finances. We look at the benefits and drawbacks of debt consolidation loans.
What is loan consolidation?
You can use a debt consolidation loan to clear a number of smaller debts. Loan consolidation just means grouping your debts into one loan, you will only have one creditor to deal with and just one monthly repayment.
Debt consolidation loans can reduce the pressure that you’re feeling from creditors. Bear in mind that debt consolidation loans often spread the debt over a longer period of time, meaning that you may be in debt for many years.
Is a debt consolidation loan right for me?
You should think carefully before choosing a debt consolidation loan, because there may be better options available to you. Debt consolidation loans only transfer your debts, unlike bankruptcy or an Individual Voluntary Arrangement (IVA), which reduce the amount you pay back.
If your existing debts carry high interest rates (e.g. on credit cards or store cards), you may be able to get a loan with a lower rate. If you have high levels of debt, banks may only offer you a loan with a high interest rate.
You’ll need strong willpower if you take out a debt consolidation loan, because the credit cards that you clear with your loan will remain open (unless you close the accounts). The temptation to continue spending beyond your means may be hard to resist.
If you’ve already consolidated your debts, it’s probably not wise to try consolidating again. A more formal debt solution might be more effective at helping you break the cycle of debt.
Benefits of loan consolidation?
A debt consolidation loan may help you:
- Reduce the number of creditors you have to deal with.
- Reduce the level of interest that you pay (only if your bank will offer you a reasonable interest rate).
- Reduce your monthly debt repayments to an amount you can afford.
- Avoid damaging your credit rating (IVAs and bankruptcy damage your credit rating).
Drawbacks of loan consolidation?
Debt consolidation may not suit you because:
- Your poor credit rating makes getting another loan impossible.
- You may have to secure the loan against your home, leaving it at risk of repossession.
- You may be tempted to continue spending on your credit cards.
- The interest rate on your loan may rise – further increasing the length of time it takes you to clear your debts.
- You can’t afford the repayments.
Choosing a debt consolidation loan
Borrowing more money in order to pay off debts is rarely a good idea. So think carefully before consolidating your debts with a new loan.
If you’re good at controlling your spending and are keen to avoid the penalties that come with IVAs and bankruptcy, then a debt consolidation loan might be what you need.
Before making a decision, speak to an impartial advisor to get advice on all available options.
Alternatives to debt consolidation loans
Depending on your level of debt and your circumstances, you may find that an Individual Voluntary Arrangement, bankruptcy or a Debt Relief Order is a more helpful way to take control of your debt. The Consumer Credit Counselling Service or the Citizens Advice Bureau offer free, impartial debt advice and will help you understand your options.