Loans Guide

Debt consolidation loans

Updated: Thursday 16 Tuesday, 2012

By Martin Fagan

What is a debt consolidation loan and how do I know if one will work for me?

A debt consolidation loan can be taken out to pay off several other debts. For example, if you have several credit card debts or smaller loans you could use a debt consolidation loan to pay these off, leaving you with just one large loan.

Some people get debt consolidation loans in order to secure a lower interest rate, reduce monthly repayments, or for the convenience of making just one repayment a month to a single lender.

Compare debt consolidation loans

However, if you get a loan to reduce monthly repayments and the new consolidation loan has a longer term than your old loans, you need to be aware that the longer the loan’s duration, the more you’ll be paying back in interest overall. Plus, while many types of loan, such as a bank loan and credit cards are unsecured, more frequently debt consolidation loans will be secured on assets such as your house, so if you can’t meet the repayments you risk losing your home.

In this guide we explore how to make a debt consolidation loan work for you.

• The comfort zone
• So the key word here is ‘discipline’?
• Understood. Didn’t you mention a debt-free future?
• There are so many loan providers out there. How do I choose the right debt consolidation loan?

The comfort zone

Unless you’re prepared to tighten your belt and budget, a debt consolidation loan will not work and become an even heavier financial millstone around your neck. On the other hand, should you live within your means and spend wisely while repaying a debt consolidation loan, then you could be looking towards a debt-free future.

Once the loan hits your account, don’t be lulled into a “comfort zone”. Having a few thousand pounds sitting dormant can be a very tempting prospect, but it’s there to pay off debts, not for new spending. For this reason alone, many debt consolidation companies insist they pay your debts off for you. They know from costly experience that people who have spent their way into trouble and need to borrow to buy their way out of it are perhaps not the most financially prudent people to advance money to.

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So the key word here is ‘discipline’?

Without a doubt: debt consolidation loans, especially if they’re taken out to cover excessive spending on store cards, will only work if you curb your spending while paying these loans back. Those with a history of overspending should perhaps think twice before applying for this type of loan. An unsecured adverse credit loan may be more appropriate in these cases.

A number of lenders will only issue this type of loan if you agree to include your property as collateral against the likelihood of your defaulting on the loan. You need to be certain you will be able to cope with the loan repayment, as your house could be at risk if you default. This should act as enough of a health warning to not enter into a loan agreement without considerable forethought.

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Understood. Didn’t you mention a debt-free future?

Yes, provided that you stick to the rules. It’ll take a prolonged amount of time with a debt consolidation loan though, so don’t expect to get rid of your debts overnight.

With a debt consolidation loan you may be able to reduce your monthly outgoings, pay a lower rate of interest, or be able to spread the costs out over a longer time period. These loans will also enable you to improve your credit rating, provided that you consistently keep up with repayments. Not only could you emerge from this loan debt free, but it could also boost your chances of being accepted for credit in the future.

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There are so many loan providers out there. How do I choose the right debt consolidation loan?

If you are struggling to manage multiple debts and decide that you need to convert them into one monthly payment with a debt consolidation loan, you should do the following:

• Work out your total debt amount - You need to calculate how much you currently owe, which will help you decide how big a consolidation loan you will need to pay off your debts. While it may be tempting to add a little extra to the loan amount to treat yourself, don’t do it. Borrowing more will cost you even more in interest in the long run, and you’ll probably be in debt for longer, so only borrow what’s necessary and resist spending more of tomorrow’s money today.
• Check your credit report - Not only will checking your credit report reveal to you how you look to prospective lenders, it also gives you the opportunity to correct any information that is wrong and give yourself the best chance of being approved.
• Make a budget - If you are planning to take out a debt consolidation loan, it’s crucial you make a budget and stick to it. You need to ensure that you can meet your new repayments and don’t get into further debt. Making a budget will help you work out how much you can afford to pay towards your debt each month and so will help you choose a loan term that suits you.

Once you have done these things, you are ready to compare loans. You should aim to compare deals from several providers to find the best one for your circumstances.

As well as looking at the interest rates on debt consolidation loans, you also need to watch out for extra costs such as arrangement fees.

Crucially, to work out whether a debt consolidation loan is right for you, you need to compare both the monthly repayments and the total amount you’ll pay to what you would pay if you continued with your existing debts.

And remember, if your debt consolidation loan is secured on your home, you risk losing your home if you can’t meet your repayments, so don’t enter this type of agreement lightly.

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THINK CAREFULLY BEFORE SECURING ANY DEBTS AGAINST YOUR HOME.
YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON A MORTGAGE OR ANY OTHER DEBT SECURED ON IT.