What is debt consolidation?
It is where you borrow money to pay off your existing debt, normally to reduce your monthly outgoings or to make it cheaper.
For example, if you have three loans and two credit cards that total £15,000 you borrow a single £15,000 loan to pay them off.
What are the pros and cons?
Reduce your monthly payments
Could be cheaper to pay off
Only owe money to a single lender
Could take longer to pay off
May have to pay fees
Could cost more in the long run
What debts can be consolidated?
You can consolidate any debts that can be paid off early, including:
Debt collection agency debt
Outstanding utility bills
What is a debt consolidation loan?
This is a personal loan you can use to pay off your debts; there are two main types:
Secured: Where the loan is secured against something you own, often your home.
Unsecured: Where the lender has no claim on your belongings or property.
Most personal loans can be used for debt consolidation but double check before you apply because not all do.
Are there any better alternatives?
Yes, there could be, so shop around and compare your options before you apply for a debt consolidation loan. Look at these other options first:
Use your savings: If you have savings you could save money by using them to pay off some of your borrowing. Here is how to work out if it is right for you.
0% money transfers: They work by transferring money from a credit card into your bank account. You have to pay a small transfer fee (around 4%) but then have a set amount of time to pay off the balance interest free.
Peer to peer loans: They work by borrowing money from other people online. Rates will depend on your credit rating and how much you want to borrow.
When should you consolidate your debts?
Consolidating is not always the best option, especially if it will increase how much money you owe or make your payments unmanageable.
You should only consolidate if the solution you have found is:
Still affordable each month
At a lower interest rate
Does not extend your loan term unnecessarily
Check the total cost
The best way to work out if consolidating will save you money is to work out the total cost of your existing borrowing vs. the total cost of consolidating your debts.
For example, if you owe £10,000 in total spread over two loans and a credit card here is how consolidating could work:
£5,000 loan charging 11.9% APR with 3 years left to pay. Paying £164.40 a month, total cost £5,918.27.
£3,000 loan charging 7.9% APR with 1 year left to pay. Paying £260.45 a month, total cost £3,125.39.
£2,000 on a credit card charging 18.9% APR, which will take 2 years to pay off. Paying £100 a month, total cost £2,380.
All three added together would give you:
Total monthly payments = £524.85
Total cost = £11,423.66
If you borrowed £10,000 to pay off these debts over three years at a rate of 3.9% APR the new amounts would be:
Total monthly payments = £294.49
Total cost = £10,601.75
In this example consolidating would reduce your monthly payments by £230.36 in the first year and over the three years save you £821.91 in interest charges.
How to consolidate your debts
If you have decided to consolidate your debts follow these steps:
Work out how much you owe: Add up your outstanding debts by checking the balance for each and if any charges apply to get an accurate figure.
Choose between secured or unsecured: If you need to borrow over £25,000 you may need to choose a secured loan, otherwise pick unsecured.
Decide how long you need to pay: Try to avoid extending your borrowing for any longer than you need because it will cost more.
Look for the cheapest interest rate: Rates vary depending on how much you need to borrow and for how long, so this should be your last step.
Applying for the loan
Once you have found the right loan, or have chosen another way to consolidate your debts, you need to apply for the new borrowing.
You need to show that you can afford the monthly payments, but if your loan is for debt consolidation you can usually specify this during the application.
This means you do not need to include the payments you make to your existing borrowing when giving details of your bills.
What happens next?
Once your application has been approved you need to set up the payments on your new loan and arrange to pay off your old borrowing.
One of the biggest risks facing borrowers who have consolidated their debts is that they take on more short term borrowing, increasing how much they owe, so try to avoid this.
What else can you do?
One of the best ways to cut your debts is to spend less and free up more of your money to pay off what you owe.
Debt consolidation FAQs
Can I get a debt consolidation loan with bad credit?
Yes but it may cost more. If you took out your existing loans before you had bad credit they may be cheaper.
How many debts can I consolidate?
As many as you like. If you can borrow enough to pay off what you owe there is no limit to the number of debts you can consolidate.
Will a debt consolidation loan affect my credit score?
Yes, your debt consolidation loan will appear on your credit record, but once you have paid off your old borrowing those loans will show as settled.
Are my debts paid off automatically?
No, you will be sent the money and will then need to pay off each of your debts using the money.
Who can get a debt consolidation loan?
As with all loans the lender will check you can afford the payments and your credit record before you apply.