As personal debt in the UK rises, more and more people are looking for help. Debt consolidation loans are among the tools rising in popularity.
What is a debt consolidation loan?
Debt consolidation loans work by borrowing money to pay off all or most of your outstanding debts. These are usually for credit cards, store cards and personal loans. Then you only owe money to the one lender. Ideally, you repay that debt at a lower cost with a monthly payment plan.
Types of consolidation loans
There are two kinds of debt consolidation loans, and it is important to know the difference between them:
- A secured debt consolidation loan: these are tied or “secured” to a valuable asset, like your home or car. If you miss payment, you risk losing that asset.
- An unsecured debt consolidation loan: these are not linked to any valuable assets.
Always seek professional advice before considering either type of debt consolidation loan. While it may seem a straightforward option, there are also hidden risks that can make either option unsuitable for you.
When should and shouldn’t you consider a debt consolidation loan?
Review your persona circumstances to know if it is a good idea to consolidate your debt with a loan.
On the one hand, a debt consolidation loan is a good idea if the savings are significant and you can afford to keep up payments. On the other, if you cannot afford to keep up with monthly loan repayments, debt consolation loans are probably too risky.
Also worth considering is your credit score. If you can keep up with the repayments on time, debt consolidation can improve your credit score. But if you are late or fall behind, your credit score will suffer.
You need to run the numbers carefully before agreeing to a consolidation loan. For example, how much money do you expect the loan to save you in the long term? And how does that compare to your interest charges on existing payments? Are you really saving less? And if there is a significant difference, can that saving be wiped out by fees and charges?
Money Dashboard can help pull your numbers. It can also help you see the realities of your financial situation such as the impact of losing a monthly paycheck due to job loss or illness. If your situation changes and you can’t make a payment, is the risk acceptable?
Be very cautious with the fees and charges for debt consolidation loans
The best way to consolidate debt is at the lowest cost and risk to you. Which is why you need to look out for any extra or hidden fees to clear existing debts. This can make the loan more expensive, cutting down potential savings.
Alternates that don’t put your home at risk
When you’re faced with a lot of bills from different creditors at different rates it can be overwhelming. The idea of consolidating into one loan can seem like the obvious answer, but there are more options that don’t put your home on the line.
For example, 0% or low-interest balance transfer cards are a great alternative for many. These allow you to consolidate your debts into one credit card and pay off the balance at 0% interest for an extended period. Read more about 0% balance transfer cards and how they work here.
If you have a good credit score, you may find unsecured personal loans the better option. Unlike consolidated loans or 0% balance cards, you are borrowing a fixed amount from a financial institution like a bank or credit union, and pay fixed-amount instalments over a set period of time until the debt is completely repaid.
Best practices to choose a debt consolidation loan in the UK
If you are sure that debt consolidation loans are right for you, begin your search on comparison websites like moneysupermarket for the best deal. And shop around, ask for quotes before you apply, and see if the lender can do a soft credit check, which does not get noted on your credit history.
Remember to look past the interest rate and other headline figures. The fine print matters a great deal.