A debt consolidation loan is a financial product designed to let people combine all their existing debts into one manageable monthly payment.
Like all debt solutions, this kind of loan has some advantages and some disadvantages, so it’s useful to understand exactly how debt consolidation loans work.
Here, we’ve explored loans for debt consolidation in some detail – so you can decide if it’s an option you’d like to explore.
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What is a debt consolidation loan?
A debt consolidation loan is a type of loan that’s specifically for people who want to pay off other debts.
A consolidation loan can be helpful in a few different ways. Firstly, it means you don’t have lots of different payments to make each month. Instead, with all your debts rolled into a single new loan, you’ll just have one monthly repayment.
Of course, there’s also a chance to significantly lower your monthly repayment too. This will usually mean stretching the overall debt and loan amount out over a longer period, but it can sometimes be a good way to help you get back in control of your finances.
What kinds of debt can be included in a debt consolidation loan?
Strictly speaking, virtually any kind of debt can be paid off with a debt consolidation loan – but some types of debt are more suitable than others. The most popular types of debt that people clear with a consolidation loan include:
- Credit card debts
- Personal loan debt
- Store cards
- Payday loans
If you find yourself in a position where you’ve previously consolidated loans and you’re considering consolidating again, you may need help from debt professionals getting back on top of your finances. Continuing to consolidate loans could affect your credit history and you may find yourself creating bigger financial problems further down the line.
How does taking out a debt consolidation loan work?
The process of consolidating debts is fairly simple – and it starts with adding up everything you currently owe.
When you calculate the total amount you owe, you should call your current lenders and make sure your ‘settlement’ figure (the full amount you’ll need to pay off) is definitely accurate. For instance, if you have a loan and you want to pay it off early, you might find there are additional fees to add on.
When you’ve got the exact figures, it’s time to add up all your outstanding debts; this is going to be the amount you apply for with your new loan. If you need any help with this step, the loan provider you’re looking at using will probably be willing to help.
When applying for your loan, you should be clear with the provider exactly what you’re going to use it for. They might have special interest rates available for this type of consolidation loan.
Assuming your credit rating meets the new lender’s criteria and all their other checks are okay, you’ll be accepted for the loan and you’re likely to receive the money into your bank pretty quickly. As soon as possible, you should contact each of the lenders you have current debts with and arrange paying them off in full. It’s important to act fast so no additional interest or fees are added.
From this point forward, you will only have a single monthly payment to make – and your previous lenders will send you letters confirming that your debt has been settled.
The two different types of debt consolidation loan
Not all debt consolidation loans are the same. In fact, there are two distinct types – so it’s useful to understand which is better suited to you.
An unsecured debt consolidation loan
An unsecured debt consolidation loan is one which does not rely on having anything as ‘security’ (something that a lender can repossess if you fail to keep up with payments).
This means that with an unsecured loan, your home and other possessions are not at risk.
Unsecured loans are seen as slightly riskier for lenders though; so they’re often only available to people with a good credit rating. You might also find you’re paying a higher interest rate compared to loans that are secured against your home too.
Secured debt consolidation loans
A secured consolidation loan is one which uses your home or another property you own as security. This means that if you fail to keep up payments on your secured loan, your home could be at risk.
This type of consolidation loan is sometimes referred to as a ‘homeowner loan’. This kind of loan is often offered to people with lower credit scores as a way of reducing the risk to the lender.
Is a debt consolidation loan a good idea?
Consolidation loans aren’t always a good idea – and whether or not one will work for you will depend on your unique financial circumstances.
To decide whether or not a loan to consolidate debts is a good idea for you, it’s worth asking the following questions:
- Do you have a stable source of income?
- Can you afford to keep up with your new loan payments until the debt is totally cleared?
- Can you be certain that you’ll cut back on the spending and avoid getting more credit after you’ve got your loan?
- Are you sure you’re getting a better deal or interest rate – even when you’ve considered the length of the new loan?
- Do you have a reasonable credit score so you can avoid high interest rates?
If you can confidently answer ‘yes‘ to all of those questions – then exploring consolidation loans in a bit more detail might be a good step for you.
When is a debt consolidation loan not such a good idea?
A consolidation loan is only a good idea if you can be confident that you can avoid any kind of problem spending going forward.
Problem spending is the kind that takes you beyond your monthly financial means. If you’re finding that you need further credit cards or personal loan products (payday loans for example) to cover your spending and your bills, getting a consolidation loan might just be putting off the need for a more permanent debt solution – like Individual Voluntary Arrangements (IVAs) or a Trust Deed.
If you feel like you need help with your finances or you’ve got any doubt about whether a loan is going to really help you in the long-run, now’s a good time to seek professional debt advice.
Is a debt consolidation loan right for you?
It’s important to remember that your finances are unique to you – so you should never feel pressured into exploring a debt solution that doesn’t sound perfectly suited to your circumstances.
A debt consolidation loan can be a useful way to get out of financial difficultly – but it’s absolutely vital that you remember why you took it out in the first place.
Many people who use debt consolidation loans go on to use further credit products, potentially putting themselves in a worse position than before. If you’re using a debt consolidation loan to get yourself out of financial trouble, avoiding further credit in the future also means you’ll be avoiding money-related stress.
Debt consolidation loan pros and cons
Like any solution that helps you get back on top of your finances, debt consolidation loans have some advantages and some disadvantages.
We’ve covered most of them already – but we’ve recapped them all here so you can decide whether or not debt consolidation loans are something you’d like to look into in any more detail.
Advantages of using a Debt Consolidation Loans
- Your monthly payments will be reduced – especially if you have arrears or products at high interest rates
- It’s much easier to keep track of a single repayment instead of trying to pay back lots of smaller debts
- Clearing previous debts and keeping up with your new monthly repayments will help to improve your credit rating
- You’re likely to get a lower overall interest rate when you borrow enough to cover all your previous debts
Disadvantages of using a Debt Consolidation Loans
- You generally need a good credit rating to take a large consolidation loan out – this can make it difficult if you’ve already run into problems with missed payments
- You might find you have fees or penalties to pay for settling your other debts. This can make it impractical to consolidate what you owe
- Although a debt consolidation loan has the convenience of keeping everything in one place, you might find you can track down better rates by shopping around and looking at credit cards, personal loans, or other debt solutions.
- Since a debt consolidation loan is a financial product, missed payments will damage your credit rating – and you’re unlikely to be able to change your agreement if circumstances change
- If you’re consolidating debts with a secured loan, missed payments could eventually lead to your home being repossessed
- Unlike IVA or Trust Deed debt solutions, a consolidation loan doesn’t write-off any debt – and may actually cost you more in interest in the long-term
- Since you need a good credit history, you might find that you’re offered much higher rates of interest if your credit rating could use some work