If you have debt in more than one place, using a personal loan to consolidate what you owe into one manageable monthly payment could be a convenient way to reduce the amount of interest you pay and help you pay off your debt. debts faster.
We take a closer look to help you assess if this is the right choice for you.
How to consolidate your debts with a personal loan
Combining multiple types of debt – such as credit card and store card balances, loans, overdrafts, and payday loans – into one monthly payment can make it easier to manage your finances and potentially save you money. a decent amount of money.
One way to do this is to use a personal loan. The amount borrowed through the loan can be used to pay off your existing debts, and you will then pay off your new lender in monthly installments, ideally at a lower interest rate.
This means that you will only have one payment to make each month, rather than several, and one lender to process.
What is a personal loan?
Personal loans typically allow you to borrow between £ 1,000 and £ 15,000, although you can borrow up to £ 25,000 from some lenders. You can usually repay this amount over one to five years, with some loans lasting a little longer.
Personal loans are unsecured, which means that they are not secured by an asset, like your home.
Secured loans, on the other hand, are secured against your home, which means that if you default, the lender can take steps to repossess it.
What are the advantages and disadvantages?
There are many advantages and disadvantages of using a personal loan to consolidate debt. It’s important to understand them before deciding if it’s the right tactic for you.
- You only make one payment per month to a single lender, making managing your finances easier to manage and simpler
- You may be able to reduce the amount of interest you pay on your debt – rates are most competitive for loan amounts over £ 7,500
- Reducing the amount of interest will help you pay off your debt faster
- Personal loan monthly payments are fixed, which makes budgeting easier
- You choose the length of time you have to repay the loan, usually up to five years
- Paying on time each month can help improve your credit score.
- Not all lenders will allow you to use a personal loan to consolidate debt, so check before you apply.
- The most competitive personal loan rates are only available to people with good credit scores, so if yours isn’t up to par, you may be offered a higher rate.
- Depending on the interest rate offered to you, the monthly payments could end up being higher than before
- Payments are not flexible so if you miss a payment it can affect your credit score
- The longer the term of your loan, the more interest you will pay
- There may be an arrangement fee to pay, as well as a prepayment charge if you want to prepay your loan.
- You may have to pay a prepayment charge on one or more of your existing debts if you are solving them with a new personal loan.
What to consider before applying
If you want to use a personal loan to consolidate existing debt, it is important to assess whether it will definitely save you money overall.
To do this, first check whether you will have to pay a prepayment charge to pay off your initial debts before the end of the term. If so, it may outweigh the savings you would make by taking out a personal loan.
Next, figure out exactly how much you need to borrow (add up the total cost of your current debt, including prepayment charges) and assess whether you are likely to be able to borrow that amount.
You will also need to think about how long you will need to repay the borrowed amount. Remember, if you go for a longer loan term, your monthly payments will be lower, but you will pay more accrued interest.
If it looks like you’ll end up paying more for a personal loan than if you kept your debt where it is, or if you think you won’t be able to afford your new one-time monthly repayment, a personal loan is unlikely to be. your best option.
Likewise, if you are on the verge of settling your existing debts, consolidating them is unlikely to make financial sense.
However, if you are happy to go ahead, it is worth checking your credit score before applying to give you an idea of how likely you are to be accepted for the best deals.
What are the alternatives ?
While a personal loan can be a useful way to consolidate debt, there are a few other options you can consider.
Balance Transfer Credit Card
If you have debt on a number of credit cards or credit cards, transferring that debt to a balance transfer card can be an easy way to manage it.
If you choose a 0% balance transfer credit card, you won’t have to pay interest on your debt for several months. It could save you a lot of money and help you pay off your debt faster.
Be aware, however, that most balance transfer cards incur a fee of around 3% of the amount you transfer, which will be added to your balance. And, if you don’t resolve your balance within the 0% period, you’ll start paying interest.
Alternatively, some balance transfer credit cards have a low annual percentage rate (APR) for the life of the debt, rather than 0% for a limited period. This means there is no pressure to have your debt paid off by a certain time – and some low APR balance transfer cards don’t charge a transfer fee.
Just keep in mind that your credit card’s credit limit may not be enough to consolidate all of your debt, and the best deals are usually only offered to people with a good credit rating.
Money transfer credit card
A money transfer credit card allows you to transfer funds directly from your credit card to your bank account. You can then use these funds to pay off your existing debt, as long as the credit limit is high enough.
If you choose a 0% money transfer credit card, you won’t have to pay interest for a fixed period of time. However, like balance transfer cards, there is usually a transfer fee to pay (often around 4% of the amount involved) and once the 0% deal is completed, interest will kick in.
A secured loan usually allows you to borrow a larger amount than a personal loan (often £ 25,000 or more) and you can often pay it back over a much longer period (up to 25 years). Interest rates can also be lower than for personal loans.
The big downside, however, is that secured loans are secured against your home – meaning if you can’t keep up with your repayments, you risk losing it. They should therefore only be considered if you have considered all other options and are confident that you can make your repayments every month.
This type of secured loan is sometimes referred to as a second mortgage because it is actually a separate loan in addition to your primary mortgage.
This can be a useful option if you don’t want to remortgage (see below) as it will incur prepayment charges on your existing mortgage.
Free up your home equity
Another option is to remortgage and release the equity in your property – it’s usually best to do this if your current mortgage contract comes to an end, otherwise you may have to pay a prepayment charge.
Provided that the value of your property – and therefore the amount of equity in your home – has increased, you might choose to take out a new, larger mortgage and use some of the equity to pay off your other debts.
However, keep in mind that your mortgage amount will increase, so your monthly payments are also likely to increase, even if you get a mortgage with a lower interest rate.
Plus, because you’ll be borrowing for a longer period of time than a personal loan or credit card, you’ll end up paying more interest.
Also be aware that if home prices go down, so will your home equity. This could potentially leave you in negative equity, where the size of your mortgage is greater than the value of your property.