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12 Things to Know About Debt Consolidation Loans

6 minute read

By Hannah Stephens

If you’re finding it tough to keep up with debt repayments, you’re not alone. According to The Money Charity’s statistics archive, the average UK household has debts totalling £63,122. Fortunately, you have several options available to help you pay off your debts and enjoy more financial freedom.

Debt consolidation loans are one way to make debts more manageable and escape the vicious circle of making minimum debt repayments every month. However, they’re not the right choice for everyone, and they could even make problem debt worse in some circumstances. Below, you can find out 12 things everyone should know before taking out a debt consolidation loan.

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1. A Debt Consolidation Loan Combines Your Debts

A debt consolidation loan combines all your existing debts, such as credit cards and overdrafts, into a single loan. After your loan is approved, you use the money to pay off your current credit accounts. You’ll then pay an agreed monthly amount to your loan company, including interest. Therefore, you won’t need to worry about managing multiple repayments to different creditors each month.

2. Debt Consolidation Loans Can Reduce the Interest You Pay

Many people choose to take out a debt consolidation loan because it allows them to pay less interest. As of 2022, companies offer interest rates as low as 2.8% for loan amounts between £7,500 and £15,000. Compare that to the 25% average APR on a credit card, and it’s easy to see why debt consolidation can make financial sense in some circumstances.

However, the lowest interest rates will only be available to people with excellent credit scores. The interest rate you’re offered may differ from a company’s advertised APR. It’s a good idea to compare several loans to find the best rate and check that it’s cheaper long-term than repaying your existing accounts.

3. Your Credit Score Could Take a Hit Initially

When you apply for a debt consolidation loan, lenders will carry out a hard search on your credit file to assess the risk of lending to you. A hard search will lower your credit score slightly, even if you’re refused credit or decide not to take the loan.

Your credit score may also suffer if you decide to close your existing credit accounts after paying them off. Having mature credit accounts can make you more attractive to lenders. Reducing your available lines of credit will also increase your credit utilisation percentage, which can be harmful to your credit score. On the other hand, you may be better off closing your old credit accounts if you’re worried you’ll be tempted to rack up more debt in the future.

4. Debt Consolidation Can Positively Affect Your Credit Score Over Time

Although applying for a debt consolidation loan is likely to reduce your credit score initially, it could help you build a better score over time. Many people find it easier to keep up to date with their debt repayments when they only have to make one monthly payment.

If you’re paying less interest on your loan than you were on your old credit accounts, you may be able to pay off more of the debt each month. Therefore, your credit utilisation percentage will reduce quicker, which is good for your credit score.

5. Structured Payments Can Help You Clear Debt Faster

Some types of debt, like credit cards and overdrafts, have no set repayment structure. Therefore, you can get trapped in a cycle of paying the minimum amount on your debt without any realistic prospect of ever clearing the balance. Often, you’ll end up paying more on fees and interest than you do on repaying the credit, a situation known as persistent debt.

One of the primary benefits of a debt consolidation loan is that it comes with a structured payment plan, usually lasting between one and five years. Therefore, you can be sure when your debts will be paid off, as long as you keep up to date with payments.

6. Longer Loans Are More Expensive Over Time

Spreading a debt consolidation loan over a longer period can significantly lower your monthly repayments. However, the longer the loan period, the more you’ll pay in interest and fees. In some situations, you could end up paying more over the loan’s lifetime than you would by gradually paying off your existing credit accounts. Therefore, it’s wise to keep the loan period as short as possible to reduce the total interest you pay, providing you can afford the monthly payments.

7. You Can Use a Personal Loan to Consolidate Debt

Generally, the most affordable way you can consolidate debt is to take out a personal loan. If you’ve been searching for debt consolidation options, you may have come across debt consolidation companies. These companies may offer low monthly repayments, but they often charge large amounts of interest over time.

Be especially wary of companies offering government debt consolidation or using any wording suggesting government endorsement. The UK government does not endorse any debt consolidation lenders, and these companies often charge steep fees for services you could get free from non-profit organisations like StepChange.

8. Keeping Up to Date With Repayments Is Essential

If you take out a debt consolidation loan, it’s important to keep up with your scheduled payment plan. Failure to make payments could result in late fees, which can quickly add up. Missed payments can also have a significant negative impact on your credit score.

However, you can ask for help from your lender if your circumstances change and you’re unable to make your monthly payments in full. They may offer a new repayment plan or freeze your interest charges to make things more affordable.

9. Balance Transfer Cards Are an Alternative to a Debt Consolidation Loan

Some credit cards allow you to transfer existing debt and pay 0% interest (or a very low interest rate) for a set period. Balance transfer cards let you transfer credit card debt, while you can use a money transfer credit card for overdrafts and high-interest loans. Paying the debt back within the interest-free period helps you avoid paying any more interest.

Balance transfer cards are a cheaper way to repay debt than a debt consolidation loan, but they’re not suitable for everyone. Firstly, you’ll need a decent credit score to get approved. You’ll also need to be disciplined about paying the balance off because the interest rate will increase significantly at the end of the 0% period. If you’re not sure you have the willpower to manage repayments yourself, a personal loan could be a better option.

10. Secured Loans Can Put Your Home at Risk

Most personal loans from banks and other creditors are unsecured. However, secured loans are available that use your home as collateral if you’re a homeowner. You may find it easier to get a secured loan than an unsecured loan if you have a poor credit history, but the lender could repossess your home if you don’t keep up with repayments.

Secured loans may also have variable interest rates, which means you could end up paying a much higher interest rate than initially. It’s best to speak to an independent financial advisor before committing to a secured loan.

11. Debt Consolidation Isn’t Right for Everyone

A debt consolidation loan could make your problems worse if you don’t tackle the reasons you’re in debt in the first place. It won’t be a good choice if you can’t afford the monthly repayments.

The primary risk is that you could end up using your old credit accounts to pay for essentials, and some people begin running up new debts because they mistakenly believe their debts have been cleared. Therefore, they end up in even more debt than before. It’s essential to commit to resisting accumulating more debt for debt consolidation to work.

12. You Can Get Help With Unmanageable Debt

If your debts are so large that you can’t tackle them, several charities and non-profit organisations can help. These include StepChange the Citizens Advice Bureau. You may be eligible for the government’s Breathing Space debt respite scheme or a Debt Management Plan to help reduce your monthly payments.

Is Debt Consolidation Right for You?

Debt consolidation could be a good option for you if you can afford to make the repayments and access a lower interest rate than you’re currently paying. If in doubt, it’s best to consult an independent financial advisor to weigh your options before committing to a debt consolidation loan.

Hannah Stephens

Contributor