What is a Debt Consolidation Loan?

What is a Debt Consolidation Loan?

A debt consolidation loan is a way of refinancing your current debts to combine them into one singular loan. This can make it easier for some people to manage their cashflow and keep track of their outgoings, it can also potentially lower the amount of interest you will pay across the course of the debt repayment. You can use a debt consolidation loan to pay off credit cards/store cards, personal loans and overdrafts.

How does Debt Consolidation work?

Debt consolidation usually works by taking your existing debts with various lenders and turning it into one loan that is payable to just the one lender. It means you can go from having multiple payments coming out throughout the month at different amounts and varying interest rates to having only one payment come out at a set interest rate and with a set payment.

This can mean reducing your payments overall, paying back at a lower interest rate, or paying back over a longer period, but in a structured way, designed to help you get more in control of your borrowing. However, there may be fees involved and it may cost you more in the long run, depending upon your current interest rates and the period of the loan.

You may also be able to consolidate your debts in different ways, such as by transferring all of your credit card debt onto a single card with a lower or even 0% interest rate. So it’s important you know what your options are and how much they will cost you both in monthly repayments and over the long term before you make your decision.

When should you consider a Debt Consolidation Loan?

If you are struggling to manage your finances and keep track of who needs paying when, then a debt consolidation loan could be a good option. It can also be helpful if you have several high interest debts, by combining them into one singular consolidated loan where you may be able to take advantage of a better interest rate.

However, as with all credit, the rates and amount you are offered are likely to depend on your credit history and it may not always be the best option for you. Plus a lower interest rate does not necessarily mean a lower amount of interest overall - a loan paid back over a long period of time will cost more in interest than the same loan amount and interest rate over a shorter period of time.

What types of Debt Consolidation Loans are there?

There are two types of consolidation loans, secured and unsecured. Usually unsecured loans are offered on debts up to £25,000, and for anything over that, you’re more likely to be looking at a secured loan. The difference between an unsecured loan and a secured loan is important as secured loans may mean your home is at risk if you don’t meet payments.

Secured Consolidation Loans

A secured loan is something that is taken out against an asset (something you own), usually your house - as such they are often called ‘homeowner loans’ or ‘second charge mortgages’. The important thing to note here is that if you miss repayments, the lender can repossess whatever the loan is secured against as collateral to pay off your debt. If this is your home, then you are at risk of losing your home should you fall behind. Secured loans are usually offered if you owe a large amount of money and because they are in effect a change to your mortgage, you should seek expert mortgage or equity release advice.

Unsecured Consolidation Loans

An unsecured loan means that the loan is not secured against an asset. It’s a ‘personal loan’ and it’s just tied to you as an individual. If you fall behind with an unsecured consolidation loan, it works in the same way as falling behind on any other form of unsecured lending.

What you must consider before applying for a Debt Consolidation Loan

Before you apply for a debt consolidation loan it’s important to think about the following things:

  • Can you afford the repayments? You need to be sure that you can afford the repayments on a consolidation loan right through until it is paid up. Any missed payments and arrears on your consolidation loan will be recorded on your credit history. If you’re worried that you can’t afford, or may struggle to afford in the future, the monthly repayments on a consolidation loan then it could be worthwhile talking to someone like a debt advisor to get some advice on your options.

  • Being in the right frame of mind. Getting to the stage of wanting a debt consolidation loan means that you are willing to start tackling your debt. Which also means it’s a good time to get back on track with a budget and plan to pay it off. That may mean using a consolidation loan to give you the breathing space you need, or it could just mean taking a really good look at your spending and borrowing to restructure how you borrow and how you pay back. Getting some help with your options, with what your debt will cost each month and overall means you can make the right decision for you.

  • Know exactly what you owe. If you are taking a consolidation loan then you want to make sure that it can adequately cover your current debts. For example, if it’ll only cover some of your lower interest debts and leaves your higher interest rates ones sitting there, then it may not be the right option to take. Leaving yourself with unmanageable debts, debt that could easily become unmanageable or insufficient money to live on is unlikely to be helpful in the long run. If you’re taking out a consolidation loan, make sure you put yourself in a sustainably better position and don’t rely on future windfalls or improving circumstances that may not happen.

  • Beware of “government debt consolidation”. There is no such thing as a government backed debt consolidation loan, meaning the government is not helping anyone with free or official loan services. There are government introduced debt solutions, such as DROs (Debt Relief Orders), IVAs (Independent Voluntary Arrangements), bankruptcy or debt arrangement schemes, but these are all formal debt management solutions, rather than consolidation loans. They all attract large fees and typically, significant consequences so should be considered very carefully and with impartial advice from the Money Advice Service, StepChange or similar to guide you. The FCA (Financial Conduct Authority) is taking action against misleading advertising.

  • What are the interest rates and fees? It’s great if a consolidation loan can save you money on the interest rates you’re currently paying but you need to make sure that any money you are saving isn’t wiped out by set up fees/charges, and that you understand the overall cost of your debt when using a consolidation loan and how it compares with your current circumstances or other options that may be available to you. Which is why it is vital you take a really good look at your options before you make your final decision. There are few silver bullets to managing debt so being smart about your options is key.

How to get a Debt Consolidation Loan

It’s important that you shop around when it comes to debt consolidation loans as you want to make sure you are getting something that works for you and puts you in a better position financially.

The first thing to do before even looking at loans is to know where you are financially - you will need to know what debt you owe to who, what you currently repay each month and at what interest rate. With that information you can then make an informed choice about which loan will best suit you and the amount you need it to cover.

If you decide a consolidation loan is right for you, then it’s also really important that you are disciplined about your borrowing going forward. That means avoiding running up debt again, for example on credit cards or overdrafts, as you will have even more to pay off and could find yourself with borrowing you can no longer manage. Cutting up your credit cards and deleting saved card information online will help you to avoid temptation.

Sign up to the ilumoni app today

Get the ilumoni app for a better overview of your borrowing. ilumoni can help you to see if there are steps you can take to improve your repayments and change how you borrow to make sure you borrow well.

For money worries, all of the following will help you for free:

AdviceUK www.adviceuk.org.uk 0300 777 0107

StepChange Debt Charity www.stepchange.org 0800 138 1111

Citizens Advice (England & Wales) www.citizensadvice.org.uk England: 08444 111 444 Wales: 08444 772020

Money Advice Scotland www.moneyadvicescotland.org.uk 0141 572 0237

Citizens Advice (Scotland) http://www.cas.org.uk 0131 550 1000

National Debtline www.nationaldebtline.co.uk 0808 808 4000

Citizens Advice (Northern Ireland) www.citizensadvice.co.uk

The Money Advice Service www.moneyadviceservice.org.uk 0800 138 7777

Mental Health helplines:

Samaritans www.samaritans.org 116 123, email jo@samaritans.org (24/7)

CALM www.thecalmzone.net 0800 58 58 58 (nationwide), 0808 802 58 58 (London) + webchat (5pm – midnight daily)

Papyrus HOPELINEUK (under 35s with suicidal feelings) www.papryus-uk.org 0800 068 4141 (weekdays 10am-10pm, weekends and bank holidays 2pm-10pm), email pat@papyrus-uk.org, text 07786 209 697

Shout www.giveusashout.org 85258 (24/7 text service)

The Mix (under 25s) www.themix.org.uk 0808 808 4994, text THEMIX to 85258 + webchat (4pm-11pm daily)

Other useful resources:

Mental Health and Money Advice www.mentalhealthandmoneyadvice.org

Mental Health Foundation www.mentalhealth.org.uk 020 7803 1101

Mind www.mind.org.uk 0300 123 3393

Relate www.relate.org.uk