Loans Guide

Debt consolidation loans

What is a debt consolidation loan and how do I know if one will work for me? (Updated 22/7/09)

A debt consolidation loan is a loan that 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, or to reduce monthly repayments, or for the convenience of making just one repayment a month.

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However, if you get a loan with a longer term to reduce monthly repayments, you need to be aware that you will be paying more interest overall. Plus, while some debt consolidation loans are unsecured, more frequently they 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
• Discipline
• It takes time
• Our recommendation

The comfort zone

You must be prepared to tighten your belt and budget accordingly or a debt consolidation loan will not work. 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 bright, debt-free future.

Don’t be lulled into a ‘comfort zone’ once the loan hits your account. 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.

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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 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 need to 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 likely 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 that you make a budget and stick to it. You need to ensure that you can meet you 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 deal 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 you home if you can’t meet your repayments, so don’t enter this type of agreement lightly.

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