Looking to clear debt? Then a debt consolidation loan may help, but how do they work?
Debt consolidation loans – who are they for?
If you are currently looking to clear debt and juggling payments to more than one lender, you are not alone. Britain as a nation, owes over £1 trillion. But rather than trying to pay off the minimum amount for each debt, a debt consolidation loan could reduce your debt to one manageable monthly payment. However, you need to look at all of the relevant issues as loan consolidation may not be right or available for you.
What are debt consolidation loans?
In its simplest terms, a debt consolidation loan will pay off your existing debts and transfer the monies owed into one loan with one manageable, monthly repayment. You will still have to pay back all the monies owed, but with loan consolidation you may be able to reduce your monthly outgoings, pay a lower rate of interest, or be able to spread the costs out over a longer time period.
What are the benefits?
If you are careful about managing your spending, debt consolidation loans can help by:
- reducing your monthly payments. By spreading out the term of the debt you will often be able to reduce your monthly repayments to a manageable level. Most people are often paying the ‘minimum payment’ allowed on the existing debts. This often just means covering the interest component of the loan while leaving the actual total amount owed unchanged.
- improving your credit rating. If you are able to pay off the loan and accrue no further debt, this will be seen as a positive impact on your credit rating. It is also a good idea to check your credit report before you apply for a debt consolidation loan.
- reducing the interest you pay. If your debts are with store or credit cards that have a high interest rate, then you will generally pay back less interest on your debt with a loan. Make sure you stop spending on your cards though.
Dangers of a debt consolidation loan
You may find yourself getting into debt for a longer period than needed, so it’s important to weigh up all the alternatives you could take to reduce your debts or help pay off your existing ones.
These loans should not be the first action to take against debt, especially if there are expenses and outgoings you can reduce or get rid of completely.
It’s worth analysing your budget and looking at what you can afford to pay back on your current debts first.
How do I get a debt consolidation loan?
To see if you are eligible for their loan, a lender will look at how much debt you have outstanding and your credit risk.
If you have a previous history of bad credit or large debts, a lender may only consider offering a secured loan. This will require you using your property as security against the loan, reducing the lender’s risk. You need to be very sure you will be able to cope with the loan repayment, as your house could be at risk if you default.
Today, the majority of personal loans can be used to consolidate your debts. As with any other borrowing the lender will look at:
- the amount you want to borrow
- your credit history
- how long you need to repay the debt
If your outstanding debt is low and you have no problems with your credit rating, a personal loan could help you consolidate and reduce your debt.