Need help managing your debts? If you’re considering debt consolidation, we’re here to explain how it works and whether it might be the right option for you
What is debt consolidation?
In a nutshell, debt consolidation is when you take out a new type of credit – usually a personal loan – and use it to pay off all your other debts.
Instead of having multiple loan payments to manage each month, you’ll have replaced them with one larger loan.
There are many reasons why you might be considering consolidation, whether it’s to lower your interest rate, reduce your monthly repayment amount, or simply make your finances more organised and easier to control.
However, debt consolidation isn’t right for everyone – and it’s important to note that it’s not a type of debt management.
Not sure what’s best for you? Don’t panic; we’re here to help. Read on to find out more and decide if consolidation is a good idea for you or not:
How does debt consolidation work?
Depending on your situation, you might be thinking of consolidating your debts using a new personal loan, a credit card, or a home equity loan.
If you choose to take out a new loan, you’ll need to submit an application first.
That also means you’ll need to meet the lender’s eligibility criteria. That could mean having a good credit score, a stable source of income, and enough disposable income available each month to cover your new monthly loan repayment.
You’ve been approved? Congratulations! Now you can use your loan to clear the balances on all your smaller debts.
All that’s left to do now is make your new monthly payment amount on time and in full each month until your loan term comes to an end.
Consolidation could work a little differently if you’re dealing with credit card debt. In this case, you’ll apply for a new card with a high enough credit limit to cover all your existing balances. If you’re approved, you can then transfer your existing credit card balances onto your new card and start making monthly payments until it’s all paid off.
How will debt consolidation affect my credit score?
Debt consolidation can have both a positive and a negative impact on your credit score – and a lot will depend on how you act once you’ve consolidated.
When you apply for your consolidation loan or a new credit card, don’t be alarmed if your credit score dips slightly. That’s because having a new hard credit check on your credit report can temporarily affect your score.
The good news is, once you start making repayments, your score should recover quickly. You might even be able to improve your credit even further if you make your new payments on time (especially if you’ve missed them in the past) and start reducing your overall total debt.
On the other hand, if you fall behind with your new consolidated debt payment, your score could be negatively impacted, and you could find it tough to secure finance again in the future.
When is debt consolidation a good idea?
Debt consolidation can work well if your debts are affordable but you’re struggling to keep them all organised.
When you have multiple different types of debts, it can get confusing quickly. Each debt will likely have a different payment amount, a different interest rate, a different loan term, and a different payment date.
It’s all too easy to get mixed up and accidentally miss a payment or pay off a loan with a low rate of interest when tackling the higher rate debt would have been more financially beneficial.
Enter debt consolidation.
Instead of juggling several repayments, you’ll combine them all into one. One loan, one payment amount, one interest rate. Make that single, structured payment each month – or even overpay if you can afford to – and you’ll be more likely to pay it down without missing a payment.
What are the risks of debt consolidation?
While debt consolidation can help you get back on track with debts that are getting out of control, it’s not a debt solution and it won’t work for everyone.
Firstly, you’ll need to be in a stable enough situation to qualify for a new loan. If you’ve been struggling for a while and now have a poor credit score or have lost your job and can’t make payments on any of your debts anymore, you probably won’t be eligible for a consolidation loan.
You also need to be disciplined if debt consolidation is going to be successful. It won’t fix any pre-existing spending habits or magically increase your income, so if you start missing payments and owing more in interest, you could end up in an even worse situation and with even more debt!
It’s also not necessarily going to be the cheapest way to clear your debts. Depending on the loan term and interest rate, you could end up with lower monthly payments but a longer term, so you’ll pay more in interest over time.
What are alternatives to debt consolidation?
If debt consolidation isn’t the right fit, there are several other options available:
- Use a 0% credit card
If you have a strong credit score, good self-discipline, and a relatively small amount of debt, you might be able to consolidate using a zero-interest credit card. These cards will typically charge no interest on your balance for a set period. By consolidating your debts onto a 0% credit card, you can work out how much you need to pay each month to clear the full amount before the interest-free period ends.
- Negotiate a debt management plan
An informal way to manage your debts, a debt management plan (DMP) can help you negotiate a new payment plan with your creditors so you can get back on track with your debts. This might be the best solution for you if you’re having a temporary financial setback – you’ve just been made redundant, for example – and need to reduce your loan repayments until you’re back on track.
- Enter an Individual Voluntary Arrangement
An Individual Voluntary Arrangement (IVA) is a formal debt management solution that could help if you’re finding it tough to make your repayments. With the support of an Insolvency Practitioner, an agreement will be proposed to your creditors to reduce your repayments for a set period. Once your IVA is in place, you won’t be charged any extra interest, although your credit score will be impacted, and you might find it tough to find finance for up to six years.
Looking for a friendly team of experts who can help you explore your debt management options? We’re here to help. Give us a call on 0161 768 4601 or send a message here.
