Debt consolidation is a way of merging multiple debts into a single loan, making it easier to manage your creditors and keep track of your payments.
Entering into any debt solution has the potential to negatively affect your credit score, including debt consolidation. However, the impact of debt consolidation on your credit score depends on how you manage your repayments.
What is debt consolidation?
Debt consolidation is the process of taking out a loan and using the money to repay multiple debts. It can be used to deal with many types of debt, including credit cards, personal loans, store cards, and overdrafts.
The purpose of a debt consolidation loan is to help you streamline your existing debts by going from multiple payments to just one. Because you’re only making one repayment, you might also pay less interest.
For example, if you have £3,500 worth of credit card debt, £4,000 of loan debt, and £1,200 of store card debt, you can apply for an £8,700 consolidation loan to help you repay what you owe over a series of monthly payments.
However, like all forms of debt repayment, debt consolidation is not suitable for everyone. It also won’t reduce the amount you owe and you’ll be expected to make payments until you’ve repaid 100% of the debt.
Before applying for a debt consolidation loan, it’s important to consider all options and compare your financial situation against the eligibility criteria to ensure it’s the most suitable option for you.
How much debt do you have?
How does debt consolidation work?
The process of consolidating your debts is fairly straightforward. We’ve outlined the steps typically involved in the debt consolidation process below:
Review your financial situation
Before starting the debt consolidation process, it’s important to review your financial situation to determine if it’s the right solution for you. It can help you repay your debt in a way that’s much more manageable for you, but it’s not the only option available.
For example, if you only have one or two low-interest debts, it might not make the most financial sense to take out a debt consolidation loan to repay them. Generally, debt consolidation best suits individuals who have multiple high-interest debts, like credit cards.
Add up your total debts
The next step in the debt consolidation process is to add up your total debts. This includes any credit cards, personal loans, store cards, and overdrafts you have.
Once you have a clear idea of how much you owe, you can know how much to ask for when you submit your application. It can also be useful to research debt consolidation loan providers at this stage and use an online debt consolidation loan calculator to estimate how much your monthly payments are likely to be.
Apply for a debt consolidation loan
Now that you’ve done all the necessary preparation, you can start the process of applying for a debt consolidation loan. Each provider has their own application process, but most of them require the same information, such as your total debt level, disposable income, and credit history.
When you apply for a debt consolidation loan, you’ll also be asked to submit some financial documents, such as bank statements, credit card bills, and tax returns, to give the lender a well-rounded picture of your finances.
Start your monthly repayments
Once your debt consolidation loan application has been approved, you can start making monthly repayments towards your debt. It’s important to stick to the terms and conditions of your debt consolidation loan to ensure it’s a success.
Failure to keep up with your monthly repayments can lead to the lender asking you to repay the debt in full, which can cause further financial hardship. This can also have a disastrous impact on your already damaged credit score.
Can debt consolidation affect your credit?
Most debt solutions negatively affect your credit for several years. This includes a debt consolidation loan.
When you apply for a debt consolidation loan, a hard inquiry is made on your credit report. This is just to check that you’re a suitable candidate, but it will temporarily lower your credit score.
Your credit score also plays a key role in determining the type of loan you are offered. For example, if you apply with a good credit score, you’re more likely to be offered favourable terms and low interest rates. However, if your credit score is poor, you’ll be subject to high interest rates and might even struggle to find a lender altogether.
Remember, debt consolidation can make it easier for you to manage and repay your debts, but it’s still a loan. Therefore, it’s important you do your research and weigh up the pros and cons before deciding to apply.
The longer you maintain your payments on a debt consolidation loan, the more your credit score will grow over time. This will make it easier to access credit again down the line as it shows you’re a responsible borrower capable of sticking to a payment schedule.
“No fuss, just simple, honest advice. Communication is good and they make the process as easy as they can.”
Is debt consolidation right for me?
Before applying for debt consolidation, it’s important to do your research to know if it’s the right solution for you. Even if you qualify for a debt consolidation loan, there might be an alternative option better suited to your circumstances.
The best way to determine if debt consolidation is right for you is to look at the various advantages and disadvantages:
Advantages
Fewer monthly payments
The main advantage of a debt consolidation loan is that you’ll go from making many monthly payments to just one. This can make it easier to manage your essential payments (e.g. rent and bills), reducing the likelihood of you ending up in further debt.
Although your total debt won’t be reduced, having fewer monthly payments to worry about can ease your financial stress.
Lower interest rate
Your credit score will determine the interest rate you’re offered, but fewer monthly payments can mean you pay less in interest over the term of your repayment period.
This could also mean that your total debt repayment amount is reduced.
Faster debt repayment
Minimising your interest rate can result in you repaying your debt faster by shortening the time you’re making repayments.
The sooner you can eliminate your debt, the sooner you can move on and make a fresh financial start.
Disadvantages
Eligibility requirements apply
Like all loan types, you’ll need to meet certain eligibility criteria to qualify for a debt consolidation loan. Each lender has their own set of factors they’ll assess to determine if you’re a suitable candidate for debt consolidation.
The main things most lenders look for are a stable monthly income, paid employment, and a good credit score.
Upfront fees
Even if you qualify for a lower interest rate, there could still be upfront fees required, such as an origination fee or balance transfer fees. These fees are usually worked out as a percentage of your debt.
Calculating any upfront fees before you apply can help you know whether any potential savings could be outweighed by these extra costs.
Damaged credit score
The aim of debt consolidation is to help you manage your monthly payments and improve your financial situation. However, missing payments on a debt consolidation loan can cause further damage to your credit score.
In some cases, missing a payment by as little as 30 days can cause your credit score to drop considerably.
What are some alternatives to debt consolidation?
Debt consolidation is a way to combine multiple unaffordable debts into one monthly payment, but it isn’t for everyone.
Here are some common alternatives to debt consolidation:
Home equity loan
A home equity loan is a second mortgage that lets you borrow against the equity tied up in your home.
When you take out a home equity loan, you’ll receive a lump sum payment that can be used for various reasons, including consolidating your debt.
The interest rate on your repayments will usually be fixed, meaning it won’t change for the duration of your loan term (typically 25 years).
Balance transfer credit card
A balance transfer credit card can help you repay your debt faster by moving existing credit card balances from one card to another with a lower interest rate. Used wisely, it can help you regain control of your debt.
Most balance transfer credit cards come with a 0% interest rate for a limited time, meaning you pay nothing in interest for a set period.
Because of this, you might be able to pay off your debt quicker.
Bankruptcy
Bankruptcy is another alternative to debt consolidation that can help you eliminate the debts you can’t afford to pay. It works by pausing all debt repayments and legal action for 12 months, which can allow you to focus on starting over with your finances.
Once your bankruptcy order concludes, all debts included in the arrangement will be written off.
However, while bankruptcy can give you some much-needed relief from your debts, it can have a serious and lasting impact on your credit and is not a decision that should be made lightly.
Debt help tailored to you
From writing off a large portion of your debt, to readjusting your budget, we’ll find a solution that suits you.
Can I use debt consolidation to improve my credit?
Debt consolidation can harm your credit rating if you fail to keep up with your payments, but it can also be used to improve your financial standing in the long term.
For example, consolidating your debts can lower your credit utilisation ratio (the percentage of available credit you’re using). This can have a direct impact on your credit score, boosting your chances of being approved for more credit accounts (e.g. a loan or a mortgage) down the line.
Consolidating your debt also makes it easier to make your payments in full and on time, which has a direct impact on your credit score. Remember, your payment history is the single most important thing lenders look at when considering you for credit.
Conclusion
Debt consolidation is a way of combining multiple debts, taking you from several monthly payments to just one monthly payment. When you consolidate debt, you’ll usually benefit from a lower interest rate, meaning you’ll pay less over time.
Like most debt solutions, missing payments will cause your credit score to drop for up to six years. Lenders will then be able to see you’re in debt and might reject your credit application based on this information.
It’s important to weigh up the pros and cons of debt consolidation before applying. Even if you do qualify, there might be another solution better suited to your circumstances.
