Struggling with multiple credit repayments? A debt consolidation loan could help you simplify your payments, understand your debt better, and even reduce the interest you pay. But it’s not suitable for everyone, and there’s lots to consider before you act.
Here we’ll look at what debt consolidation is, how it works, and what your options may be.
What is debt consolidation?
Debt consolidation is when you move some or all of your existing debt from multiple accounts (e.g. credit cards and loans) to just one account. To do this you’d pay off – and potentially close – your old accounts with credit from the new one. Your debt won’t disappear, but it will all be in one place.
Is it a good idea to consolidate my debt?
Consolidating your debt with a loan can have several benefits:
- Simpler budgeting. Instead of wading through various statements and juggling multiple payments, you’ll make one set monthly payment on the same date each month
- A clearer view of your debt. Having all your debt in one place can make it easier to see how much you owe, how quickly you’re paying it off, and how much interest you’re being charged
- Potentially lower rates. You may be able to reduce the amount of interest you’re paying by consolidating your debt under one lower interest loan
However, debt consolidation isn’t right for everyone, and it can have some downsides. Here’s what you should consider before getting a debt consolidation loan:
Debt consolidation loans – what to be aware of
- Total cost of the loan. Even if the new loan has a lower rate than your existing credit accounts, the amount of interest you pay overall may be more if you have the loan for a much longer time
- Early repayment penalties. Some companies will charge you if you want to pay off the loan before the end of its term. Check the terms of your agreement for details
- Set-up fee. You may be charged a percentage of the amount you’re borrowing to set up the loan
- Impact on your credit score. For example, applying for a loan and closing old accounts can have a negative impact on your score
What are my alternatives to a debt consolidation loan?
Balance transfer credit cards
If the debt you want to consolidate is on credit cards, you could move it to a 0% balance transfer card. As well as simplifying your payments, you’ll benefit from paying no interest for a set promotional period – which might be between 3-40 months depending on the offer.
Some things to be aware of first:
- You may be charged an initial balance transfer fee
- You’ll need to make at least the minimum monthly payment – on time and in full – to keep the promotional rate
- Once the promotional period ends, you’ll usually be put on the company’s standard rate. It’s best if you can pay off the card before this to avoid paying interest
- Closing your old credit cards may affect your credit score.
Negotiating directly with your lenders
Another alternative — and one that many people consider as their first step — is to contact your lenders directly to explain that you’re struggling to pay them, and to discuss your options. It’s best to do this as soon as possible, rather than waiting to miss a payment or default on your account.
Companies can find it difficult to recover money from someone once they default, so they may be willing to accept a reduced payment or waive penalty fees. It’s worth noting that reduced payments will be marked on your report and will likely lower your credit score – plus, it’ll take you longer to pay off your debt.
Speaking to debt charities
If you’re struggling with repayments, you may be approached by companies promising to help you wipe out your debt. Be cautious. They may charge you hefty fees, and it’s possible to end up with even more debt and/or a damaged credit report.
Getting support from a reputable, non-profit organisation is usually a much safer option. Examples are StepChange and National Debt Line. These charities can advise you on ways to deal with debt, such as a debt management plan or an Individual Voluntary Arrangement, both of which will probably have a negative impact on your report and score.
How does debt consolidation affect your credit score?
Debt consolidation can affect your credit score in different ways, depending on how you go about it. Here are some reasons why your score may be positively affected:
- By simplifying the way you budget and make payments, debt consolidation can help you make repayments on time and in full. Over time, this kind of responsible financial behaviour should improve your score
- If a debt consolidation loan helps you pay less interest, you may be able to make larger monthly payments than you did with your previous accounts. This means you’ll pay off your debt quicker, which can improve your score
And here are some reasons why your score may be negatively affected:
- Applying for a debt consolidation loan – or any form of credit – will record a hard search on your report. This can temporarily lower your score. But as long as you don’t apply for credit frequently, your score should recover quickly
- Closing old accounts may also reduce your score. This could be for two reasons: firstly because some companies like to see that you have mature accounts, and secondly because your overall credit limit may drop, causing your credit utilisation (i.e. the percentage you use of the credit available to you) to increase
- Using a debt management plan (which is often advertised as debt consolidation) may require you to fall behind on your payments, which can lower your score
What’s the difference between debt consolidation and debt management / settlement?
Debt management plans (DMPs) – also sometimes known as Debt Settlement Plans – are often advertised as debt consolidation, but they’re not the same as getting a debt consolidation loan. The main difference is that you’ll stop paying companies you have credit with, and start making one regular payment to a debt management firm, which will negotiate a ‘settlement’ with those companies.
It’s important to know that this can seriously damage your credit report and score. One issue is that late/missed payments may be recorded on your credit report. What’s more, if your debt is settled, your report will show you didn’t pay the companies in full. Your score will probably go down as a result, reducing your chances of getting approved for credit in the near future.
How can I get a loan for consolidating debt?
As with any type of credit, you’ll need to apply for the loan and meet the lender’s requirements to get it. They’ll use information from your credit report, application form, and their own records to decide whether to lend to you, and at what rate.
If you have a low credit score, you may struggle to get a good rate – or even to get approved at all. Luckily, there are several steps you may be able to take to improve your score. It’s worth looking at your free Experian Credit Score to get an idea of how lenders may see you.
It’s also helpful to compare loans with us to find an offer that’s right for you. It’s free and won’t affect your score. Plus, you can see your eligibility for personal loans and credit cards, helping you understand your chances of approval before you apply.
Just remember, we’re a credit broker, not a lender†.
Can I consolidate my debt if I have bad credit?
Even if you have a low credit score, you may be able to get a debt consolidation loan. Secured loans are usually easier to get approved for than personal loans – this is because they use an asset, such as your house, as collateral to reduce risk for the lender. However, you may lose the asset if you don’t keep up with repayments, so a secured loan is not to be taken out lightly.
Guarantor loans are another common option for people with bad credit. With this type of loan, someone will need to promise to make your repayments if you can’t. It carries risk for both the borrower and the guarantor, so make sure you do your research and read the terms carefully.Compare loans with Experian