How can debt consolidation benefit you?

Paying off multiple debts at the same time can be both complicated and challenging. Debt consolidation can help you to combine all of your existing debt into one loan which can offer you better control over your financial situation.

We take a look at what debt consolidation entails, and we then consider the benefits of debt consolidation and how it can improve your credit score over the long run.

Debt consolidation is when you take out a new loan to pay off your other debt. In other words, you take out a consolidation loan and use the money to settle all your other debt. This then leaves you with a single loan to pay off rather than several, high-interest accounts to manage.

If you have a good payment history and credit score, you are bound to get approved for a consolidation loan with favourable conditions, such as an overall lower interest rate.

Debt consolidation can be especially helpful for paying off old loans, credit card debt, and other liabilities. It can be done in the form of a loan or even a new credit card. Lenders are willing to offer debt consolidation loans for many reasons. For starters, it increases the likelihood of getting their money back from borrowers.

If you’d like to understand this in more depth, you can read our guide to debt consolidation loans. Here, we consider the different types of consolidation loans and all the other factors you should be aware of.

Debt consolidation allows you to manage your debt effectively by combining all the pending loans into a single loan. Doing this has two main benefits:

• Lower interest rate: Depending on your credit score, a consolidation loan may lower your overall interest rate. This means you have more money going towards settling your actual debt.

• Longer repayment period: Even if you don’t get a lower interest rate, debt consolidation will lower your overall monthly payments by extending the period of the loan.

Besides this, debt consolidation also reduces your stress by simplifying your debt. You no longer have to fret about balancing numerous monthly payments that you’re struggling to afford. Instead, you have a single payment that doesn’t strain your budget.

The downside of debt consolidation is that you will end up paying more towards your debt. However, this is the price you will have to pay to reduce your monthly instalments to a manageable amount. Overall, it’s better to pay slightly more and ensure you’re able to settle your debt, than pay slightly less and default on your credit agreements.

Over the long run, debt consolidation may increase your credit score. This is because it takes the pressure off your debt payments and allows you to gain control of your finances again.

Your credit score may temporarily go down when you take out your consolidation loan. This is because your overall credit limit and the age of your accounts will adjust as you settle your other debt. An enquiry will also be noted on your credit report, which may slightly reduce your credit score.

However, as long as you make your new payments on time and you don’t add more debt on top of your consolidation loan, then your credit score will start to grow again. Here are some long-term benefits from consolidating your debt:

• Lower credit utilisation ratio: This is the ratio of the credit you’re using versus the overall credit limit that’s available to you. When you get a new loan or credit card approved, it decreases your credit utilisation ratio which in turn leads to an improved credit score. See my credit utilisation.

• Better payment history: It might take some time, but as you start to pay off your new loan, your credit score will start to slowly increase. After all, your payment history is one of the biggest factors that will influence your credit rating in the long run. See my payment history.

Watching your credit score improve is one of the main advantages of taking out a consolidation loan. This will also prepare you for future credit products, such as a home loan, and ensure that you will qualify for credit whenever you need it.