Debt consolidation loans
What are they and are they a good idea?
If you're struggling with multiple debts such as loans, credit cards and overdrafts, it may seem logical to consolidate them into one place – taking out a new loan to pay it all off, so you make one monthly payment instead. However it's often not that simple and can lead to even more debt. This short guide takes you through what to watch out for, alternatives and how to decide if it's right for you.
What is debt consolidation?
Put simply, it's about bringing all your debts into one place. So rather than having multiple payments to different lenders, potentially on different dates, you just have the one payment to make.
This is usually achieved by taking out a new personal loan to cover the total amount of debt you owe, then using the cash to pay off all your individual debts.
How do debt consolidation loans work?
If you've multiple debts, it's highly likely each amount you owe will be different and at varying interest rates. Equally the repayment amounts and the rate at which it's being cleared will differ – so it can be a job in itself to keep on top of how much you owe, and when you need to pay it.
This is particularly true with overdrafts which don't have structured repayments to clear the balance. It's the same story with credit cards if you opt to just pay the minimum monthly repayment, as your payments mainly service the interest rather than clearing the debt.
Personal loans are different, as payments are fixed and designed to clear the amount you owe by the end of the agreement, usually one to five years. The idea of a consolidation loan (just a personal loan used to clear debt) is therefore to move all your debt to its structured repayments and single interest rate. So not only do you only have one, fixed repayment to worry about, but you know when it will be cleared.
Should I get a debt consolidation loan?
Debt consolidation all sounds very logical and sensible so far – and for some it can be – but as it requires more borrowing, it has the potential to lead to even more debt.
The real key to debt consolidation is first tackling the reason you needed to borrow, and ensuring you're in a position to avoid borrowing again – otherwise you could end up in the same position, with the loan on top.
This warning can't be illustrated any more clearly than in these real-world examples from our forumites...
The last time I consolidated was 2 years ago. I got a loan for £16,000, got a nasty shock when I saw that figure written down and promised myself faithfully that I would never run up a single other debt as long as I lived. But I did. Mrs_Sparkle
Been there, done that. Now the loan is one debt among many and costing me the most. Broken_hearted
The other common misconception about consolidation is the idea that you're instantly debt-free or that your debt is now manageable and dealt with. Whilst it can be a step in the right direction, it still requires complete dedication to repay the loan on time, every time and not be tempted to borrow again. As another forumite sums up...
This is the trouble with consolidation. You're not debt free. You're debt postponed, and that's very different. However, if you are disciplined and have addressed the reasons for getting into debt in the first place, this may well be the answer for you. iolanthe07
Before considering a consolidation loan, you first need to make sure that you're in a position to pay down the loan, and not run other debts back up.
Think of multiple debts like an untidy house, where every room is unorganised and you struggle to find things. You then decide to consolidate the mess, by putting it into one cupboard or the garage. The rest of the house is now tidy, and you can set about sorting through and getting rid of the items. However, if you don't change your habits and are still an untidy person (and fill the now empty parts of your home with items again), your house could end up looking as it did before – in addition to the untidy cupboard or garage.
So for consolidation to work in the long term, there's often more of a 'lifestyle' shift or other compromises you need to make first, or at least alongside it. If you can't make this lifestyle shift, or you're not sure, you might be better seeking debt help instead. Our Debt Problems guide has help to tackle spending, plus details of charities who can give debt advice if needed.
Alternatives to debt consolidation loans
Before you go for a debt consolidation loan, the first thing to check is whether you can cut the costs of your debt, so your repayments go towards clearing more of the balance rather than just paying interest. We'll take you through that step-by-step in this section.
There's no cheaper borrowing than interest-free, so this is always the first step to try. There are two main routes for this, depending on the type of debts you have (though some with good credit histories may be accepted for both). Importantly, DON'T use them for new spending as it isn't usually at the cheap rate (and because you're trying to pay debts off, not run up new ones).
- Shift debt from existing credit card(s) to 0% with a balance transfer card. This involves getting a specialist new card that repays debts on other credit or store cards for you, so you owe it instead but at 0%.
The exact 0% period varies per card, but is often upwards of two years. The longest deals typically have a one-off fee as a percentage of the amount borrowed, yet there are cards that have no fee, so you can sometimes even shift debt for free.
See our Top Balance Transfer Cards guide for full info, top picks and our clever eligibility calculator which can show your acceptance odds before applying.
- Overdrafts or high-cost loans – use a 0% money transfer credit card loan to clear it. A few specialist cards offer a 0% money transfer that lets you pay cash into your bank for a small fee. You then owe the card instead but interest-free for a set number of months (typically 12 months or more) which is usually much cheaper than loans.
Crucially, to get the cheap rate never just take cash from an ATM. You'll need to ask your card provider for a money transfer. Full step-by-step help is in 0% Money Transfers.
This may mean you're better off keeping some debt separate, unless all of your existing debt is of the same type. Utilising 0% interest deals is by far the best way to slash debt costs, speeding up the time to repay and can save £1,000s in interest.
You'll need to be disciplined for this to work
One disadvantage of cards compared to loans is the payments aren't fixed. It's very easy with cards just to pay the minimum repayment, thinking "I've got another one (or two) years to clear this debt, I'll pay it when I've more spare cash".
Instead, it's best (crucial even) to set up a direct debit to repay a fixed monthly amount that will clear the debt within the 0% period. If you don't think you can stick to this, then even though it's costlier, it's safer to go for a traditional cheap loan.
What's the best way to consolidate debt?
If you've read all the warnings and cons of debt consolidation above, tried or dismissed the alternatives and will be disciplined enough to avoid further borrowing, then a debt consolidation loan can sometimes work, as Charlotte emailed:
In naivety I used to let my husband sort our finances, so would blindly spend. It wasn't until our relationship sadly broke down that I realised how much debt I was in – a £6,000 car loan, £2,300 on a credit card and a £1,500 overdraft I was never out of.
This gave me a sudden wake up call and I set about getting help. I used support from your forum and got my spending under control, cutting out all the luxuries I thought I needed, not taking holidays and halving my food shop.
I looked into a balance transfer for my card debt but chose to take on a loan so I knew I couldn't wriggle out of the payments. I got a lower rate than my existing car loan so cleared that and paid off my overdraft and credit card, which I decided to keep for emergencies.
I managed to get promoted at work and used this extra income to build a small emergency fund and used the rest and my annual bonus to chip away at the loan. It's taken a lot of dedication but just under three years later I've made the final repayment. I can now finally close that chapter and start saving to buy a home.
The ultimate aim of debt consolidation is to clear your borrowing in the quickest way possible. Yet taking on more borrowing is never a decision to take lightly. If you're dead set on it, this section tells you how to go about it. But first, a warning...
Avoid debt consolidation companies at all costs. Their job is to make money out of you, plain and simple. While in the short term their plans will make your payments lower, in the long run you'll end up paying far more.
For the top-pick lowest rate loans, see our Cheap Personal Loans guide. Make sure you follow our tips below to find if you can get a loan and how best to handle it...
- Work out how much you owe, then borrow only as much as you NEED to and repay it as quickly as you can
Add up the total debt you have on credit cards, overdrafts, catalogue debts, payday loans etc. Then, if you're paying off one or more loans, call your lender and ask for a settlement figure as there can sometimes be early repayment charges. Add this to your total. This is the amount you're looking to borrow. No more.
Next, work out how much you can afford to repay each month. Don't forget that once you have a loan, you won't need to make credit card minimum repayments as you'll be clearing the cards, so include any cash going to this too. Provided the amount you currently spend servicing your debt is affordable (and won't lead to more borrowing to supplement your income or lifestyle), this could be a good indicator of what you can afford.
Once you know how much you need to borrow, and how much you can repay each month, you'll then be able to work out the loan term (the length of time you want to borrow for). Use our loans calculator to help.
When using the calculator, always look at the total interest cost. A longer loan will give you a lower monthly repayment, but you'll pay more in interest as you're borrowing for longer. Similarly, the longer you borrow for, the less you'll save over your current debt costs (if anything).
- Use an eligibility calculator to check your chances of acceptance before applying
Once you know how much you need, and how much you can afford to repay each month, it's a case of finding a personal loan that you'll be accepted for. Our Cheap Personal Loans guide has full help, things to watch out for and the cheapest rates available.
Usually, applying is the only way to know if you'll be accepted for a loan. Yet that marks your credit file, affecting your ability to get future credit. To help, try our Loans Eligibility Calculator which uses a 'soft search' to find your chances of acceptance before applying. Some lenders will even give guaranteed rates (where a rate isn't guaranteed, you could be accepted but offered a higher interest rate after applying).
If you're not seeing any loans that are likely to accept you, revisit the cut debt costs section of our debt help plan guide as there are other options to try, including grants and the credit card shuffle.
- If accepted for a loan, use it to pay off all your debts which have a higher interest rate than the loan
If your loan application is accepted, the money will be paid into your bank account. Don't make the mistake of spending while your balance is artificially inflated. Instead use the money immediately to pay off your loans, cards and any overdrafts.
Most providers will let you make payments online or by phone. Whilst paying off a loan closes it, paying off an overdraft or credit card doesn't – so it will remain available for you to use unless you request for the account to be closed. There's no right answer here, but if you think the idea of available credit will be too tempting it's best to close it, or cut up the cards (so you can access it, but only in absolute emergencies). See more on cancelling old cards.
- Ensure you make the loan repayments in full and on time each and every month
Fail to do this and you'll effectively break the agreement, which could lead to penalty charges and missed payments marked on your credit report. If something later goes wrong so you can't repay, contact the lender as soon as you can and ask it for help.
Always, always tell your lender as soon as you know you're not going to be able to repay. It does work. Be firm, make a fair offer of what you can repay and be willing to answer questions about your income and expenditure honestly.
It should then offer you a fair and affordable way to repay, such as a structured repayment plan and the freezing of interest and charges.
Debt consolidation loans FAQs
A debt consolidation loan is simply a personal loan, so you're technically free to do whatever you want with the cash once received from the lender.
However as borrowing should only be for an amount you NEED over the shortest period possible, you should only use it to repay the existing debts you have.
As we warn above, a debt consolidation loan may not always help on the path to becoming debt-free, but if you're sure it's right for you then it's typically used to pay off existing loans (including payday), overdrafts and credit cards.
Potentially. At the time you're applying you're essentially doubling your debt – taking a new loan out to cover the total amount of borrowing you already have.
This can mean your affordability is impacted, as the lender has to assume you will continue repaying all the debt available to you at the time, rather than just the loan repayment.
Even if you say as part of your application that it's to repay existing debt, as there's nothing to force you to do this, it's considered as additional borrowing.
It's only when you use that cash to repay the debt that your credit file will catch up (sometimes a few months later) and reflect the original levels that the loan has replaced.
The other aspect that could have an impact is the loan application itself. Every time you apply for a credit product (eg, a loan, credit card, contract mobile phone), it adds a footprint to your file for a year.
Too many, especially in a short space of time, can trigger rejections as it makes it look like you're desperate for credit. Therefore, if you're rejected for a consolidation loan, don't immediately apply for another. Instead see the cut debt costs section of our debt help plan guide for other options to try, including grants and the credit card shuffle.
The ideal loan customer for a lender is someone with a good credit history (a proven track record of paying credit back on time) and a high level of disposable income.
Yet your credit history and your income are doing two different jobs in the lender's scorecard. We break it down here...
Credit history. Your credit record counts towards whether the lender will be willing to lend to you in the first place. But crucially it also contributes to the rate it's likely to offer you. A good credit record will make it more likely you'll get the advertised rate; if your credit history's poorer, it's likely you'll still get the loan, but you'll be repriced to a higher rate, as you're a bigger risk for the lender.
Income. Your disposable income dictates how much a lender will be willing to lend. This is worked out based on your income, minus rent or mortgage payments (and other outgoings that the lender estimates 'someone like you' would have, based on where you live and your number of dependants). And while you may have a perfect credit record, if your disposable income's not high enough (or not estimated to be high enough), you won't get the loan.
Our Loans Eligibility Calculator and Credit Club mimic these criteria when they're working out your loan chances. Credit Club also drills in to your affordability for loans and gives you a score ranging from 'poor' to 'very good' based on this.
A lender will determine whether it wants to lend you (and the interest rate it will charge) based on how risky it deems you to be. This is usually based on your credit history, and a good credit record is more likely to mean lower rates. A poorer history could still mean acceptance, but often at higher rates than those advertised as you appear more of a risk.
The best way to find out is by checking your eligibility. Usually, applying is the only way to know if you'll be accepted for a loan. Yet that marks your credit file, affecting your ability to get future credit. To help, try our Loans Eligibility Calculator which uses a 'soft search' to find your chances of acceptance before applying, including some with guaranteed rates.
If you're not seeing any loans that are likely to accept you, see the cut debt costs section of our debt help plan guide for other options to try, including grants and the credit card shuffle.
Secured loans are rarely a good move, and should be considered lending of last resort. They're only applicable in very limited circumstances.
Most high street personal loans are 'un-secured'. Annoyingly, that sounds like a bad thing, but it isn't. The alternative, and the kind you more often see advertised on TV as consolidation loans, are 'secured loans'. These can be risky for the following reasons:
Your home could be taken away
A secured loan literally means the debt is secured on your home (or something else you own), meaning if you can't repay, the lender can repossess your home. With unsecured loans, it's much, much less likely this will happen.
Personal loan rates are fixed, secured are sometimes variable
Almost every unsecured personal loan is at a fixed rate. You know exactly what you'll pay from the start, and it won't change if the UK's interest rates do, or on a lender's whim.
Yet secured loans sometimes have variable rates, meaning lenders can up your payments when they like.
Secured loan repayments are stretched over many years
Secured lenders often promise "one easy low monthly repayment". While it may sound good, it's done to stretch the debt over many years, so you pay more and more and more interest, costing you a fortune.
Important. Secured loans give the lender security, not you. It's far, far, better to take a normal unsecured personal loan than one secured on your home.
Those with reasonable credit scores should consider a personal loan, cheap credit card deals or even extending their mortgage instead.
Those with a poor credit history looking at secured loans as a way out should read the Guide To Problem Debts guide as an alternative.
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