Debt consolidation loans explained
If you have debts, then borrowing more money might seem counterintuitive, but there are good reasons (as well as risks) for considering a debt consolidation loan.
What are debt consolidation loans?
Managing debts from more than one lender can be tricky, especially if you're paying a high rate of interest. A debt consolidation loan, as the name suggests, can help consolidate all of your debts into one loan.
That loan would be used to help to pay off all of your debts and treat it as one debt, instead of several. As a result, there would only be one monthly repayment to manage, rather than many.
But convenience isn't the only reason to use a debt consolidation loan. Some loans offer lower rates than what you might be paying back on all of your credit card bills and other debts. Read on to learn how debt consolidation loans can help you.
Four reasons for taking a debt consolidation loan
- Minimise the cost of monthly debt repayments. With a debt consolidation loan, like most personal loans, the term for repaying the debt can generally be any length of time between 12 months and ten years. If you're trying to pay off a credit card balance, your debt will continue to accrue interest for as long as you fail to completely clear the debt. Spreading the repayment of all of your debts over a few years could mean that your monthly repayments are smaller than if you paid them all off individually.
- Reduce how much interest you pay. Secondly, you should aim to pay less interest with a debt consolidation loan. Due to the fact that all of your debts will be consolidated into one balance, and, especially if some of your credit cards had a high rate of APR, you should be be paying an overall lower rate of interest.
- Easier to manage. Quite simply, managing several debts can be much harder than managing just one. From ensuring your payments are made on time to transferring the correct amount each month and budgeting for your other day-to-day expenses can be much harder than paying towards a single debt each month.
- Build a better credit history. There's more risk in missing a payment when you have to keep on top of several debts. By making a single regular repayment, which would hopefully be less likely to accrue further interest when it's easier to manage, you'll be creating a better financial history for yourself. This can improve your credit score, which appears on your credit report for all lenders to see – and can affect your chances of gaining access to future credit products.
Debt consolidation loan risks
There are obviously risks in taking out any kind of credit product, but if you are already in debt, then taking out an additional loan can potentially have a much larger impact on your finances.
Most importantly, a debt consolidation should never be the first option you look at if you do have debts. The priority should be to first assess what you can do to manage your outgoings and plan to repay your debts on time.
With a debt consolidation loan there is also the risk of paying debts for much longer than you need to, so it's worth looking at the long-term situation. For example, how long would you need to realistically pay off all of your debts if they were consolidated into one loan?
Finally, if you do decide to take out a debt consolidation loan, then do not continue to spend on the credit cards which you have consolidated, as you'll end up back at square one.
When you do decide to take out a debt consolidation loan, then make sure you have a budget worked out for all your day-to-day spending, so that you minimise the need to take out any extra credit.
Applying for a debt consolidation loan
The rate advertised is subject to your application and status according to the provider, so you're not guaranteed to get the headline rate.
With that in mind, don't base all of your future debt management plans on the rate you find advertised. The lender will look at your circumstances, the amount you want to borrow, how long you want to borrow for, and your credit score to help decide if your application will be approved or declined.
The smaller your debts and the better your credit rating, the more chance you have of getting a loan, so if there's anything you can do to improve your situation prior to applying then be sure to do so. For example, getting yourself on the electoral register at your current address will improve your credit score.
Getting declined for a loan will show up on your application and could affect your score, so do check the details of the loan and if your circumstances generally fit the eligibility criteria.
Meeting the minimum eligibility criteria is no guarantee of approval for a debt consolidation loans, but there certainly isn't any point applying if you don't meet all of the minimum criteria.
Read more about Debt consolidation loans in our uSwitch loan guides.