When debts pile up it can feel really scary.
Credit cards, payday loans, rent arrears; once you start owing money to lots of different places, it’s easy to feel overwhelmed, and consolidating your debts into one loan can feel like a way out.
Paying one lender back rather than loads of different lenders – sounds like a total no-brainer.
A consolidation loan is where you merge your different debts together into a single loan to lower your monthly payments. On the face of it, it may seem simpler and look like it could save you money – but it isn’t always that clear cut.
‘A consolidation loan allows you to consolidate (meaning to combine a number of things) all of your existing debts such as credit cards into one monthly payment plan,’ explains financial adviser Sam Jennings, founder of Jennings & Co, ‘Quite often at a reduced rate with a longer term.
‘The general idea is that you take out one loan worth more than the sum of all of your existing loans, and then pay that off, using the money borrowed to pay off previous debt.’
There are two kinds of consolidation loans:
- Secured – where the amount you’ve borrowed is secured against an asset, usually your home. If you miss repayments, you could lose your home.
- Unsecured – where the loan is not secured against your home or other assets.
So, it’s really important to keep in mind that missing repayments, with a secured consolidation loan, could leave you without a home. It’s also crucial to remember that repayments on one single loan are likely to be higher.
You should never take out a consolidation loan if you aren’t sure you can afford the repayments.
‘You need to make sure it’s affordable every month as payments will need to be made,’ warns Sam. ‘The other key risk is that if you pay off all of those credit cards in order to get a consolidation loan, you become slightly more vulnerable to racking up more debt.
‘Mentally, it may feel like you no longer have any credit card debt, so it’s important that once you’ve paid off those cards you cut them up and bin them, otherwise you can run the risk of ending up with new credit card debt alongside the consolidation loan.
‘It can be easy to get in a worse position than you started at, which can be very dangerous.’
A consolidation debt isn’t a get-out-of-jail-free card, and they only really make sense if you are able to use it as an opportunity to cut your spending and get back on track.
It’s also a good idea to think about scenarios which could stop you keeping up with repayments; what if interest rates go up, or you fall ill or lose your job?
Consolidation loans also don’t make sense if you don’t clear all your debts with the loan. If you’re struggling consistently with debt you may need help from a debt adviser rather than taking out a new loan – as this won’t address the root of the problem.
But Sam says consolidation loans can be helpful in certain circumstances.
‘They are helpful for people that have a number of outstanding debts especially credit card debt. It’s for individuals who are struggling keep on top of lots of repayments and feel it’s never ending,’ says Sam.
‘A lot of people have consolidation loans to combine other debts as quite often they are actually only paying the minimum amount off each month, usually just the interest accrued.
‘Therefore they are then unable to pay off any capital and the debt is never actually going down.
‘So, the benefit of a consolidation loan is one debt with one bank. All the credit cards can be paid off to give you just one monthly capital repayment date.
‘The bonus is that the loan has an end date, unlike a credit card which is never ending. So the consolidation loan brings a structure to debt with an eventual ending, for example over three years, rather than being open-ended.’
If you’re debts are less than £25,000 in total, it is probably a better option to apply for an unsecured debt consolidation loan – because that way you don’t have to put your property at risk.
For larger amounts you would likely have to apply for a secured debt consolidation loan – but this should never be entered into lightly because the ramifications of missing payments can be huge.
It’s also important to note that debt consolidation loan applications will show on your credit report, and applying for several loans in a short space of time could have a negative effect on your credit score.
That being said, a consolidation loan can be easier for people who struggle to stick to a budget and it reduces the amount of paperwork you need to do to manage your finances.
‘A consolidation loan might be right for you if the loan is large enough for you to pay off mounting debts and is affordable every month for you,’ says Sam.
‘With a consolidation loan, the total that you owe will go down, unlike the interest and repayments on a credit card. You need to make sure you have a good credit score though before getting on and not been ignoring debts.’
Deciding whether or not to get a consolidation loan very much depends on your individual circumstances, but speaking to a financial adviser and having a thorough understanding of the risks involved is a good place to start.
This article is part of a month-long focus in November all about debt.
Scary word, we know, but we’re hoping if we tackle this head on we’ll be able to reduce the shame around money struggles and help everyone improve their understanding of their finances.
Throughout November we’ll be publishing first-person accounts of debt, features, advice, and explainers. You can read everything from the month on the Debt Month tag.
If you have a story to share, a topic you want us to cover, or a question that needs answering, get in touch at MetroLifestyleTeam@Metro.co.uk.
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