Is debt consolidation a good idea?

If you're looking to pay off your existing debts with a single monthly payment, you may be considering debt consolidation as a viable option. In this guide, we'll outline what debt consolidation is, which different methods are available, how the process works, and what you should know before applying.

What is debt consolidation?

Debt consolidation means combining multiple debts into one, usually by taking out a single loan to pay them all. The goal of debt consolidation is to go from having multiple payment dates to just one monthly payment, making it easier to manage your household bills and other outgoings.

There are several types of debt consolidation, which we've outlined below:

Debt consolidation loan

A debt consolidation loan is a single loan used to pay off multiple debts. Instead of paying each debt separately, you take out a loan that covers all of your existing debts and make a fixed payment to the loan provider on the same date each month instead of paying each creditor on different dates.

There are two types of debt consolidation loans: a secured loan and an unsecured loan. A secured loan (sometimes called a homeowner loan) uses an asset as collateral, which means you can lose your home or car if you don't keep up with your repayments. An unsecured loan, on the other hand, works in the same way as a personal loan, meaning your assets are not at risk if you miss payments.

Balance transfer credit card

A balance transfer credit card is a type of credit card that allows you to move high-interest credit card balances to a single credit card that is interest-free for an introductory period (usually up to 21 months). These types of cards usually have a credit limit of around 90-95%.

By reducing or eliminating interest, you pay back less over the course of your repayments. As with any type of credit card, it's crucial that you pay at least the minimum payment shown on your statement to avoid losing your 0% interest rate.

Debt Management Plan (DMP)

While not technically a type of debt consolidation as it doesn't require you to take out further credit, a Debt Management Plan (DMP) is often considered a form of debt consolidation because your debt is repaid in a single monthly instalment that you can comfortably afford.

The payment is made directly to the company managing your DMP before being distributed among your creditors. It lasts as long as it takes you to repay your debts in full.

How does a debt consolidation loan work?

A debt consolidation loan is the most common type of debt consolidation. Taking out a debt consolidation loan usually follows a fixed set of steps, which we've outlined here:

1. Add up your total debts

Before applying for a debt consolidation loan, you must get a clear picture of your debt. For example, if you owe money on credit card debt, payday loan debt, and bank overdrafts, add them together to calculate your total debt level.

This can give you an idea of how much you'd need to borrow to repay each of your debts.

2. Find a provider

Once you know the loan amount you need to borrow, you can start looking for a provider that meets your needs.

Before making a final decision, make sure to compare loan terms, interest rates, upfront fees, and any other factors that might affect your decision. Personal loan rates typically start from 5%.

3. Apply for a loan

If you're confident you've found the right provider and loan for you, you can begin the process of applying for a debt consolidation loan.

You'll likely be asked for information about your income, expenses, and debts to ensure you can afford the expected repayments.

4. Make payments as agreed

If your loan application is approved, the funds will be deposited into your bank account.

The average length of a debt consolidation loan is five years (60 monthly payments), but this can differ depending on the loan terms and how much you owe.

5. Stick to the terms of the loan

As well as making your monthly payments, it's important to stick to the other terms of the loan.

Failure to do so can put you at risk of late fees, collection action, and damage to your credit score, which can make it difficult to borrow money and access cheaper credit down the line.

What are the advantages and disadvantages of a debt consolidation loan?

Like all debt solutions, it's a good idea to weigh up the potential advantages and disadvantages of a debt consolidation loan before applying.

Advantages

• It may offer lower monthly repayments when interest is factored in, making it easier to manage your outgoings
• You only have to make one monthly payment instead of multiple, providing a structured repayment plan
• You may qualify for a lower interest rate than all of your previous interest rates combined
• You have a fixed timeline for repaying your debts in full
• Making loan payments in full and on time and lowering your credit utilisation can boost your credit score
• It can reduce the risk of you missing payments, with just one payment date to remember
• It can help you create sensible spending habits

Disadvantages

• There may be origination or early repayment fees
• Your debts are consolidated, but the amount you repay won't be lowered or written off
• A poor credit history can make it difficult to qualify for a good interest rate and favourable debt consolidation terms
• You could end up paying more interest if your repayment term is extended
• Combining your debts may cause you to spend more money or accumulate more debt
• It can temporarily lower your credit score by triggering a hard inquiry on your credit report
• Securing a loan to your home can put you at risk of repossession if you miss payments

When is debt consolidation a good idea?

Whether or not debt consolidation is a good idea depends on your individual circumstances.

Generally, if you're finding it difficult to juggle multiple high-interest debts and you want to streamline them into a single monthly payment with a fixed repayment timeline, a debt consolidation loan may be a suitable option for you.

The maximum amount you can borrow with a debt consolidation loan typically ranges from £25,000 to £50,000, so your included debts must fit into this threshold.

Put simply, debt consolidation is more likely to be a good idea if the new total cost is less than your current total cost once a new interest rate is factored into the equation.

It's recommended to seek free debt advice before committing to a debt consolidation loan. Even if it sounds like the perfect solution for your debt problems, there may be another option better suited to your financial situation.

When is debt consolidation a bad idea?

Like all debt solutions, debt consolidation isn't for everyone, and it can backfire if you do it for the wrong reasons.

For example, if you have a secured consolidation loan, your home could potentially be repossessed to recover the money owed if you miss payments. Even with an unsecured debt consolidation loan, a longer repayment period may equal lower monthly payments, but it can increase the amount of interest you pay overall.

Additionally, debt consolidation doesn't necessarily fix the underlying problem if your debt was caused by a spending problem or an unstable income. Some people may also continue to use a balance transfer credit card after they've used it to repay their debt and find themselves in further debt down the line.

Questions to ask yourself before consolidating your debt

Before consolidating your debt, there are a few questions you should ask yourself to ensure it's the right option for you. Here are just some of the points you should consider before you commit to consolidating debt:

• Is my interest rate likely to be higher or lower than my current debts?
• Am I happy to make repayments for the duration of the loan term?
• Have I spoken to a debt advisor and considered other available debt solutions?
• Have I addressed the underlying cause of my debt problems?
• Am I aware of any additional arrangement fees or early repayment fees?
• If it's a secured loan, am I willing to risk potentially losing my home if I miss payments?
• Have I thoroughly read and understood the terms of the loan?

“I had an excellent experience working with my debt advisor. From our very first conversation, they made me feel heard and understood - never judged. They took the time to review my full financial situation, clearly explained my options, and helped me create a realistic, step-by-step plan to tackle my debt.”

Jonathan

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What other debt solutions are available to deal with your debt?

In the UK, there are various solutions available to help you deal with your debt. It's recommended to seek free debt advice before choosing a debt solution.

Here are just some of the options that may be a better fit for you than debt consolidation:

Individual Voluntary Arrangement (IVA)

An Individual Voluntary Arrangement (IVA) is a formal agreement between you and your creditors to repay your unsecured debt in manageable monthly instalments for a fixed period (usually five to six years).

During an IVA, you'll be protected from creditor contact, legal action, and further interest and charges on the included debts. Once you've made your final payment, the remainder of the included debt may be written off.

Debt Relief Order (DRO)

A Debt Relief Order (DRO) is a formal debt solution that gives you 12 months of relief from your unsecured debts. If your financial situation hasn't improved after this time, the included debts will be written off.

DROs are often referred to as 'mini bankruptcies' as there is no application fee required and they are designed for individuals with low income, few assets, and total debts of less than £50,000.

Bankruptcy

Bankruptcy is a legal process that can allow you to write off the debts you can't afford to pay. It works in the same way as a DRO, but there is a £680 application fee required, and you may have to sell your assets (e.g. home or car) to repay your creditors.

It's important to consider the financial impact of bankruptcy. While it will stay on your credit file for six years like most other debt solutions, some lenders can view it more harshly as it's generally considered a last resort.

Conclusion

Debt consolidation can be done in several ways, including a debt consolidation loan, balance transfer card, and a Debt Management Plan (DMP). A debt consolidation loan is the most common method. It involves taking out a new credit agreement to replace multiple existing loans with a new loan, allowing you to make affordable payments and better manage your outgoings.

However, you'll need to pay interest on the new loan, and this can be more or less than you are currently paying depending on whether you have good or bad credit. It's also important to note that consolidating your debt won't instantly make you debt-free. It simply makes it easier for you to repay all your debts and can be a good way to save money.

If you're considering debt consolidation, seek expert debt advice to find out if it's the right solution for you. Mismanagement can lead to you accumulating more debt and causing long-lasting damage to your finances.