The debt consolidation loan combines all of your debts into one personal loan, which usually saves you money on interest charges.
This type of loan also simplifies your repayment schedule since you will only have to make one loan repayment per month.
Here’s how debt consolidation works and when you should consider it.
What is a debt consolidation loan?
A debt consolidation loan is a type of personal loan taken out to pay off other debts.
The money from a debt consolidation loan can be used to pay off credit cards, store cards, payday loans, buy-now offers, and overdrafts. It can also be used to repay debts owed to utility companies or housing tax, debt collectors and bailiffs.
The idea behind debt consolidation loans is twofold:
- By merging all your debts into one loan, you will only have to make one payment each month.
- To reduce the overall interest rate you pay – thereby saving you money.
The golden rule of debt consolidation is to be disciplined enough not to start borrowing again on credit cards, overdrafts, etc. – it would go against the interest of the debt consolidation loan.
How Do Debt Consolidation Loans Work?
You have to do a lot of legwork when you take out a debt consolidation loan – paying off your other debts isn’t automatic.
To get started, figure out how much you need to borrow. You can do this by adding up the amount you owe, including penalty charges for prepaying your debts.
Then you need to apply for a debt consolidation loan in which the loan amount covers what you owe. When the loan is approved, the lender will put the money into your bank account.
You then have to manually use that money to pay off your other loans.
Finally, you will need to repay your debt consolidation loan as agreed with the new lender.
How does a debt consolidation loan save me money?
Other types of borrowing such as credit cards, bank card financing, buy-it-now programs, payday loans, overdrafts, and some personal loans can carry high interest rates.
Overdrafts, for example, typically have an APR of around 40%, while most credit cards charge an APR of around 18%.
Debt consolidation loans generally offer competitive interest rates compared to other forms of borrowing. So, by swapping out a range of expensive debt for a debt consolidation loan, you will reduce the total amount of interest you pay.
Interest rates are also usually fixed, which assures you that your monthly repayments will not increase during the agreed term of the loan.
Is A Debt Consolidation Loan Secured Or Unsecured?
Debt consolidation loans can be secured or unsecured. But unsecured debt consolidation loans are almost always your best bet. They can save you money, and you won’t need to put your house (or anything else) as collateral to get one.
If you own a home but have a bad credit rating, a secured debt consolidation loan might be your only option. But be careful – you will have to pledge your property as collateral for the loan. If you default on payment, your home could be threatened with repossession.
How Long Can I Borrow With A Debt Consolidation Loan?
Unsecured debt consolidation loans are normally available against repayment terms ranging from one year up to seven years.
However, secured debt consolidation loans can last up to 25 years.
The longer the term of your debt consolidation loan, the more interest you will pay overall. But a shorter term will result in higher monthly payments.
What Interest Rate Will I Pay On A Debt Consolidation Loan?
The amount of interest you will pay on a debt consolidation loan depends on:
- how much you borrow
- the repayment term
- your credit rating
- the lender and the deal
Debt consolidation loans usually come with graduated interest rates. This means that interest rates are normally higher for small amounts than for larger amounts. The lowest interest rates are usually offered to people borrowing £ 7,500 or more.
Be aware that you might not get the APR advertised when you apply for a debt consolidation loan. Lenders need only give their overall rate to 51% of successful applicants.
How much debt can you consolidate?
An unsecured debt consolidation loan is essentially just a personal loan – the maximum loan amount will therefore depend on the lender and your personal circumstances.
Unsecured loans normally go up to £ 25,000 or £ 30,000 in some cases. You may be able to borrow more with a secured loan.
Will a debt consolidation loan have an impact on my credit rating?
A debt consolidation has the potential to improve or damage your credit score.
If you pay off your loan on time, your credit score will improve. But not tracking refunds will negatively impact your score.
When you pay off your other debts, you must close these accounts so that this credit is no longer available to you. Having too much credit available can have a negative effect on your credit score.
How much interest will I pay?
The cheapest debt consolidation loans start at around 3% APR (fixed).
If you borrow less than around £ 5,000, the interest rate may be higher than this.
You’ll also be charged more if you have a bad credit score – up to 99% in some cases.
Be sure to shop around before applying for a debt consolidation loan. Using a loan eligibility checker can help you find out which loans you are likely to be accepted for.
Is a Debt Consolidation Loan a Good Idea?
A debt consolidation loan could help you settle your finances if you:
- struggle to keep up with multiple payments each month
- have debts with high interest rates
- don’t know which debts to prioritize
- will be disciplined enough to repay the debt consolidation loan
- will save money overall
- will not be tempted to borrow money elsewhere
- can afford the monthly debt consolidation loan repayments
What are the alternatives to a debt consolidation loan?
- Balance Transfer Credit Card
If the debt you want to pay off is on one or more credit cards, a 0% interest balance transfer card might be a good alternative to a debt consolidation loan.
A 0% balance transfer card allows you to transfer existing credit card debt to a new credit card that charges 0% interest for a fixed term, usually up to two years. Most balance transfer cards charge a balance transfer fee expressed as a percentage of the amount transferred.
A money transfer credit card allows you to transfer money to your checking account to pay off overdrafts, loans, and other debts. Then you pay off the debt at 0% interest for a set period of time.
Almost all money transfer cards charge a money transfer fee, expressed as a percentage of the amount transferred.
- Re-mortgage to free up equity
If you own your home and its value has increased, you may be able to remortgage a larger amount to free up the equity. You can then use the equity to pay off your debts.