Debt consolidation: Is it right for me?

Paying off several debts to different creditors can be stressful and difficult to manage. If you find yourself in this position, debt consolidation could be a good option for you, as it’s a way of bringing your debts together. Here, we take a closer look at what debt consolidation is and whether it can help you improve the way you manage your finances.

What is debt consolidation?

Debt consolidation allows you to bring your debts together in one place. You apply for a loan that allows you to pay off your debts in one go. Then, you only owe money to one lender. Debt consolidation makes it easier to manage your monthly outgoings and can also save you money, as it can reduce your interest rate. You can consolidate various debts, including store cards, credit cards, student loans, and payday loans.

How does it work?

Let’s assume that a borrower has three types of debt:

• £500 payday loan – APR of 1000%
• £2,000 credit card – APR of 25%
• £1,500 store card – APR of 30%

The APR – annual percentage rate – indicates how much the borrower has to pay back each year. This person has £4,000 of outstanding debt and is paying weighted interest of about 50%. So, if the borrower is able to find a loan for £4,000 with a lower weighted interest, then debt consolidation is a great option. However, it’s not that simple, as we explain below.

When does debt consolidation make sense?

First and foremost, for debt consolidation to be viable, you need to be sure that it will save you money. Borrowing money over a longer period of time could mean that you end up paying more, even if the interest rate is lower. For instance, if you borrow £100 at 20% APR for one year, you will pay back £120. However, if you borrow the same £100 over a ten-year period, but with an APR of 3%, you would end up paying back £130. So, you need to calculate the cost of the loan before considering debt consolidation. You can use a loan calculator to help you work out if it’s worth it.

Secondly, you need to make sure you can afford the monthly repayments on a debt consolidation loan. Missing a payment on your loan will affect your credit score, which will affect your chances of borrowing money in the future. Although responsible lenders should conduct an affordability check, you still need to consider the affordability of a debt consolidation loan yourself. For instance, if you’re moving house, about to welcome a child, or considering changing jobs, you need to think about how these circumstances could influence your future repayments.

Consolidating debt to pay off credit cards

Credit card debt is often expensive, and taking out a personal loan to consolidate your debts can be an effective way to get the costs under control. Koyo’s super helpful guide to taking out a loan to pay off credit card debt is a good place to start. The issue with credit card debt is that it typically starts with a low rate of interest before increasing if you don’t keep on top of your payments.

Using a personal loan to consolidate debts

One of the best ways to consolidate your debt is to take out an unsecured personal loan. Modern loan providers allow you to choose how much you wish to borrow and for how long. In other words, you can set up a loan that is perfectly suited to your personal finances, and the interest rate that you pay is typically locked in for the duration of the loan. As a result, it’s a great option for consolidating your debts.

What’s the difference between secured and unsecured loans?

A secured loan is where you borrow against an asset that you have – typically your house – while an unsecured loan is available to lenders without the need for security. When you default on a secured loan, your asset is at risk. As such, you need to think carefully about affordability before agreeing to a secured loan, as you need to make the repayments on time. For amounts less than £25,000, you should be eligible for an unsecured loan for debt consolidation.

Consolidating debt with a balance transfer

In addition to personal loans, another way to consolidate your debts is to apply for a balance transfer. Some people have the option of transferring their debts to a credit card with a lower rate of APR (in some cases, zero to begin with). You need to be mindful that balance transfers often only last for specific periods of time, meaning that the rate of interest will increase after the initial period. You should also be mindful of the fact that balance transfer credit cards usually come with a fee attached, which contributes to the cost of borrowing money in this way.

Using a debt management company

If you’re really struggling with your debts, you might be eligible for debt relief. You should look at this as a last resort, and it’s not a decision that you should take lightly because it will have a lasting impact on your credit score. In this instance, your lender would put you on a debt management plan and help you to pay off your money over a longer period of time. But again, you should only go down this route as a last resort, as it will make things difficult when you apply for credit in the future.

What about fees?

Finally, you need to think about the costs of consolidating your debts. Some of the fees you might be liable for include:

• Early repayment fees: If your creditor charges an early repayment fee, you will be charged for paying your debts back early.
• Loan fee: This is an upfront fee charged by some lenders, but it’s not a feature of every form of credit.
• Balance transfer fee: This only applies to credit cards and is given as a percentage.

Final thoughts

Ultimately, consolidating your debts is a great move if it ends up saving you money. It’s also a viable option if you’re struggling to manage multiple forms of debt simultaneously and can make your life that little bit easier. Therefore, if you’re interested in debt consolidation, look for an unsecured personal loan to help you kickstart the process.