Guide to Debt Consolidation

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What you need to know

  1. Debt consolidation can help you escape debt by bringing together all your existing debts into one monthly instalment. Basically, you will take out a single loan to pay off several small ones.
  2. Merging your debts into one single repayment can help you save money and ease your worries as it makes managing your finances and dealing with a  potentially bewildering array of creditor much easier
  3. There are different methods and offers of debt consolidation, such as taking out an unsecured loan or remortgaging your property. You need to find the one that is right for you, offering you the lowest rates and best repayment plans.
  4. Before you commit, you need to be certain that debt consolidation is the best solution for you in the long-term. There are pros and cons to consider and remember it might not in fact be the best option for you.
  5. Debt consolidation can be a big help in getting back on track, but it can also cause you a lot of trouble. Only commit to a debt consolidation scheme if you are cutting down spending and are confident you will be able to pay back the new loan, including interests and fees, in the agreed time frame.
  6. Avoid any services promising to remove information from your credit score or re-write your credit history. This is impossible to do.
  7. Seek help of a debt counselling service, such as Solve My Debt or the free National Debt Line.

What is debt consolidation and why should you do it?

Debt consolidation can help you refinance your loans and escape debt once and for all. It means that you will take out an additional loan to pay off existing, smaller ones.

Under this scheme, you will not have to pay different amounts to different creditors, which can be very bewildering at times, but your payments will be amalgamated into one simple and inexpensive monthly repayment. The interest rates are usually lower and the repayment of the new loan might be spread out over a longer period of time.

However, these debt consolidation schemes also come with a price in forms of fees and "points" tied to the amount borrowed. If you are certain that debt consolidation is the right option for you, there are several routes you can go down.

What are the options?

  • Unsecured loan. This is a sum from a bank or another lender that is available at a competitive rate and requires no security, meaning your home or other assets are not at risk should you default on repayments. These types of loans are usually only available for a smaller amount of money and require a good credit score.
  • Secured personal loan. A secured loan is a sum of money, usually above £25,000 and up to £100,000, secured against a valuable asset or property. They come with different rates, fixed or flexible, and are usually repaid within ten to 25 years.
  • Credit card. Many credit cards offer very low interest – sometimes 0% - on transferred credit balances. Though there is almost always a time limit on how long you can enjoy low interest and the cards still usually charge high interest on purchases.
  • Advance from your mortgage provider. It may be possible to borrow more money from your mortgage lender, a sort of cash advance that is covered by the same terms and conditions that apply to your mortgage. Always be honest with your lender about the reason you would like to borrow more, and always have a back-up plan as they are well within their rights to turn down such a request.
  • Second-charge mortgage. This is not remortgaging, but a loan secured on property from a lender other than your mortgage provider. Remember that if you do not keep up with repayments, your home could be at risk. In that case, the second-charge lender will take its due once your mortgage provider has been satisfied.
  • Remortgaging. By borrowing based on the value of your home you can pay off your existing mortgage, with the distinct possibility of getting a better deal the second time around. Always seek expert advice before you try and remortgage a property as this is a big financial step to take.

Remember: always shop around! Too many people keen to consolidate their debts take the first opportunity available to them, unaware that there are lower rates and other options available.

What are the potential drawbacks?

Before you commit yourself, you should be sure that a consolidation loan is the best solution for you. There are cons as well as pros. It may, for example, better to contact your creditors and come to some sort of arrangement – perhaps one that allows you to make smaller payments over a longer period of time.

You must consider whether debt consolidation is cost effective in the long term. Paying off an existing debt may incur charges for early settlement, and there may also be a fee for arranging your consolidation loan.

Also, by taking out a new loan, you will be extending the period in which you are paying off debts – and that might mean a greater interest cost in the long run. Finally, many lenders add payment protection insurance to their loans without borrowers’ knowledge, which is often more expensive than similar cover freely available elsewhere.

Debt consolidation does not make sense if you are able to shift all your existing loans onto a 0%- or low-interest balance transfer credit card. This can be the cheapest and safest option if you are able to repay your debts within the 0% interest timeframe. But these credit schemes may be hard to get if you do not have a good credit history.

So you need to be confident that the interests you pay on the new loan are lower, the new loan amount does not increase the overall amount you will have to pay back (for example by extending the repayment period), and you are certain you can afford the new payment scheme.

You will also want to look out for the annual percentage rate (APR), which is not the interest rate, but a rate that includes additional fees, like arrangement fees.

In any case, make sure to seek advice from experts before you commit to a new loan scheme.

Seeking advice

Struggling with debts can be highly stressful. Plus, juggling many debts can be very expensive and an inefficient use of your finances.

Seeking the help of a debt counselling service, such as Solve My Debt or the free National Debtline, might be the answer. You can also contact impartial and free advice services, such as the Money Advice Service. All of these services offer advice on budgeting, dealing with creditors and making affordable repayments that satisfy both parties.

As well as dealing with the debts you have built up, you should also consider seeking help to stop you getting into the red again. After all, there’s no point consolidating your debts, finally getting on top of your personal finances, and then falling into arrears once again. Audit your finances and work out where you can cut back on your outgoings or even boosting your income, for instance through taking on additional work like a part-time job.

Further Reading

  • However desperate your situation might seem, there is almost always a workable solution. There are numerous other debt help organisations such as those listed here who offer free and impartial advice and have helped thousands of people get on top of their money worries
 

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