Debt consolidation usually involves taking a number of existing loans and credit card balances and combining them into one single, relatively large loan.
Why would you want to consolidate your loans like this?
There are several advantages of a debt consolidation loan. Juggling multiple debts with numerous different lenders can be confusing. Consolidating all of your debts into a single loan allows you to focus on one repayment and deal with one lender. A single repayment leaving your bank account each month will make life a lot easier.
A debt consolidation loan can also save you money. Your existing loans and debts may attract higher interest rates than the rate you will get on a consolidation loan – particularly if you have outstanding credit card balances. As the rate will be lower on your consolidation loan, you will be paying more of the balance off each month and less interest.
You may also be able to spread your repayments over a longer term. This will help to reduce your monthly payments, which can be useful if you are on a tight budget.
Debt consolidation loans can be either secured or unsecured. If you own your own home, a second mortgage may be a good option for you. Whilst you will be putting your home at risk, a second mortgage often allows you to borrow more at a lower rate of interest and over a longer term than an unsecond mortgage – meaning that you can reduce your payments as far as possible, freeing up more of your monthly cash for life’s essentials.
But while debt consolidation has many benefits, it’s always worth bearing a few things in mind before you complete your debt consolidation loan application.
As with all borrowing, it’s important that you make sure you can afford the repayments. If your debt consolidation loan is scheduled to be repaid over a longer term than the original loans you are consolidating, whilst you may be reducing your monthly payments, as you will be attracting interest for a longer term you may end up repaying more in total.
How does debt consolidation work?
You can consolidate any kind of debt, secured or unsecured, but you need to make sure that your new consolidation loan is big enough to pay of all your other loans and debts combined. You should also be sure that you can afford the repayments on your new debt consolidation loan.
Once your debt consolidation loan has been approved, either you or the debt consolidation lender will need to pay off the existing loans from the proceeds of the new loan. If you are paying off a balance on your credit card you may just need to pay the figure shown on your monthly statement, however if you are paying off loans and hire purchase the lender will normally be asked to provide a settlement figure. This is the amount they will require from you to repay the loan in full and will usually be the balance less an interest rebate. Your debt consolidation lender will usually handle all of this for you.
Once the debt consolidation loan has been paid out, your existing loans will be repaid and your credit file will be updated to show this. You can then cancel the monthly payments with your bank.
All you need to do then is to make sure you have the money in your bank account each month to cover the regular repayments.
Advantages and disadvantages of debt consolidation
Like most things, debt consolidation has its pros and cons. The main advantage with debt consolidation is that with all your loans and debts consolidated in one place, it’s much easier to manage. It takes the stress out of having to think about a list of different payments that need to be made each month by letting you focus on one payment instead.
Debt consolidation can also help you improve your credit score. How? By showing lenders that you are a responsible borrower. This is because one debt consolidation loan will replace numerous different loans and credit cards which can be closed and your credit file updated.
Borrowing over a longer term usually means that you will be paying lower monthly instalments. However as this means that the loan may attract interest for a longer period, you may end up paying more over the longer term. This needs to be balanced against the monthly savings you will see from your debt consolidation loan.