Debt consolidation is a way of refinancing a number of different debts such as credit cards, car loans and personal loans and combining them into one loan. It can make paying off your debts more manageable because instead of having multiple repayments, you only have one loan and one repayment.
There are considerations to make before deciding to consolidate your debts to ensure you end up in a better financial position than if you had kept your individual debts open.
One of the decisions you need to make if you choose to consolidate your debts is to choose whether your loan will be secured or unsecured.
Through a secured loan, a lender offers a borrower the opportunity to access funds on the basis that the loan is underpinned by an asset such as their home, savings account or a car. So if you can’t meet your repayments, the lender can sell or repossess the asset to cover the amount that has been borrowed.
In an unsecured loan, a lender will lend money without an asset underpinning the finance. Instead, the creditor assesses the loan application based on other information such as the borrower’s income. These loans typically attract a higher interest rate than a secured loan because they are riskier for the lenders.
This type of finance also means an important asset such as your home is not at risk. But if you don’t pay back the money, it could have adverse consequences for your credit score. You can check your credit score for free with.
There is a number of elements to work through before you decide whether to consolidate your debts with a secured or unsecured loan, to keep your debts the way they are or to explore other finance options.
What interest rate will you pay?
It’s important to understand the difference between how much interest you pay now and how much interest you could pay if you choose to consolidate your debts.
To make sure you will be better off by consolidating your debts, compare how much money you pay in interest now across your different loans and how much interest you are likely to pay if you consolidate your debts. Take into consideration the term, or length of time, of the loans. You may decide it’s worth paying more in interest through a debt consolidation loan if it means you will pay off your debts faster.
How much will you pay in fees?
Loans typically come with fees, so understanding what you are currently paying in fees and the fees you will pay if you consolidate your debts will help you work out the right option for you. You will need to take into account any break or switching fees your current lender will charge you with if you switch before the end of their term.
Also take into consideration any fees you will need to pay to establish the consolidation loan, as well as ongoing fees.
What’s your ability to repay your loan?
Don’t forget to factor in your circumstances when working out the right choice for you. Choosing a consolidation loan may mean you pay off more in the short term compared to your existing situation but pay off your debts faster. But make sure life events such as breaks from work to start a family or to pursue other goals such as studying still mean this option makes sense.
Also ensure that if you choose a secured loan, you are happy to take on the risk that if you can’t pay off the loan, an asset such as the family home will be used as collateral for the funds.