What are debt consolidation loans and are they right for you?
Are you thinking about getting a debt consolidation loan to manage your debt? Read below to understand debt consolidation loans.
A debt consolidation loan might sound like a way to make your debt simpler, but it could end up costing you more money. We’ve pulled together some of the essential information for you to consider before you make a decision.
What is a debt consolidation loan?
A debt consolidation loan is when you move all your debt (such as personal loans, credit cards, store cards) into one place. This means you will have one big loan to cover the amount of your current debt, rather than having several little ones. If you have this type of loan, you will only have to make one (probably monthly) repayment and, in theory, your debt will be easier to manage.
If you’re struggling with debt you may first want to speak to a debt charity like Step Change who offer free debt advice.
The two types of debt consolidation loans
A secured debt consolidation loan means the lender uses something you own – like your house – to secure your debt. If you fail to repay the loan, the lender can sell your asset to help recoup the money they’re owed. Secured loans usually have lower rates of interest than an unsecured loan because there’s less risk for the lender, but of course there’s a much bigger risk for yourself.
An unsecured loan is a loan you’re given that isn’t secured by anything you own. Instead the information on your credit report is used to help the lender establish if they want to give you the loan. If you fail to make the repayments on the loan this will damage your credit score.
Things to consider
Be aware that even though a debt consolidation loan puts all your debt in one place, it is not always the cheaper option. It will only save you money if you’re able to get a loan that beats the cost of what you’re currently paying.
We’ve put some of the things below that you should think about when working out the cost of a debt consolidation loan:
- Interest rates
Don’t make the mistake of thinking that a debt consolidation loan will cost you less in interest just because you’re being charged a single rate. Try working out about how much you are currently set to pay for your debt and compare this to how much it will cost you if you get a debt consolidation loan.
- Fees - the price of moving your debt
Before you make any decisions on moving your debt you need to check what you’ve signed up for already. Sometimes you will incur charges for moving your debt from one lender to another. Always check the small print to see what applies to you. Here are a couple of common fees that may affect you:
- Switching fees – you might be charged a fee by your current lender for moving the money you’ve already borrowed.
- Debt consolidator fees – some debt consolidation loans will require you pay a fee when you take out a new loan.
- Think about your repayment plan
Before you commit to a loan, you will have to agree how much you pay back each month and how long you will have to repay the loan. If you choose to pay back smaller amounts of money over a longer period of time this may help you manage your debt but cost you more in the long run. If you’re currently paying off your debt over a shorter period, this may end up being a cheaper option.
- Make sure you can keep up payments for the term of the loan
If you’re going to take out a new loan, think about whether your circumstances might be about to change. If you think you won’t be able to make the repayments on this loan, then it might not be right for you. This is especially the case if you get a secured loan, as you might risk losing your home if you fail to keep up with repayments.
A final thought
If you decide to go for a debt consolidation loan, you might be able to use this as an opportunity to get your debt under control. You could try creating a new budget for yourself so you can understand where you spend money, and where you might be able to save. With your debt in one place and a new budget, you might be able to cut up some of the credit cards you’re no longer using.
How can ClearScore help me?
ClearScore wants to help you make better financial decisions by giving you unlimited access to your credit report and score, for free, forever.
We’ll help guide you to the best products for you. Using the offers section of your ClearScore account will show you a range of loans that you’re eligible for based on your credit score.