Debt consolidation can be a helpful way of regaining control over your finances. While you might think the process is a tad confusing at first, debt consolidation isn’t overly complex. Below, we look at how debt consolidation loans work when you should use one, what to look for in such a loan, as well as certain alternatives that you might consider. By the end of the article, you should have all the information you need to decide if debt consolidation is right for you.
What exactly is a debt consolidation loan?
The easiest way to understand the premise of debt consolidation loans is to use an example. So, let’s assume that you owe money on three separate credit cards: £1,000 @ 20%, £1,000 at 30%, and £1,000 at 40%. Your average interest rate in this example would be 30%, which would be owed on top of the £3,000 balance. This is a relatively high rate of interest, and you’re faced with the difficulty of managing three separate monthly payments. In turn, this might lead you to pay the minimum amount due every month, which just keeps your debt going indefinitely.
A debt consolidation loan allows provides you with the funds to pay off your credit cards simultaneously. Typically in the form of a personal loan, the money is deposited into your account, and you can use it to pay off your credit cards. You will hopefully receive a lower rate of interest on the loan you’ve just taken, which will again help your financial situation in the long run.
What to consider with a debt consolidation loan
The most important thing to remember is that you should only borrow money that you will be able to pay back. While a debt consolidation loan isn’t designed to solve all of your problems, it will help. Just make sure you adjust your expenditure, so you don’t fall straight back into debt. You also need to think about the cost of a debt consolidation loan over time. For instance, paying £1,000 at 20% over two years is more expensive than paying £1,000 back at 30% APR over one year. Just because you get a lower interest rate, it doesn’t mean it will work out cheaper in the long run.
Most people can access both unsecured and secured loans as a form of debt consolidation. However, unsecured loans are much better for borrowers, as you don’t need to offer any of your assets as a security. In some cases, you might also be able to access a guarantor loan, which sees someone else ‘guarantee’ that you will pay the loan back. If you opt for a guarantor loan, you will need to find someone willing to play the role, and you will almost certainly face higher interest rates as a result.
Debt consolidation loans and your credit score
In order to be approved for a debt consolidation loan, the lender will take your credit score into consideration. While borrowers with far from ideal credit scores should be able to access credit, your options will be somewhat limited. Also, the further you go down the scale, the more interest you’re likely to pay back. Remember that there are three credit agencies in the UK, each of which offers slightly different credit scores from the other.
However, thanks to the advent of Open Banking technology, some lenders place less emphasis on credit score and consider other aspects of your current financial circumstances. Lenders like Koyo Loans use Open Banking to consider your outgoings and expenditure, which gives them a much broader picture of whether or not to issue you with the credit you’ve applied for. Another thing to be mindful of is that debt consolidation loans will affect your credit score. If you use it to your advantage and repay your loans, it will actually strengthen your credit score in the long run.
Debt consolidation loans alternatives
While a personal loan is one of the most popular ways of consolidating your debt, you can also use a balance transfer credit card. Offered by some financial institutions, this allows you to apply for a single credit card that you use to pay off all your other credit cards. Many of them begin with a 0% introductory period, which offers money savings if you can pay the loan off within that period. Once the 0% period is over, though, your interest will shoot up, so it’s important to bear this in mind if you can’t pay the money back quickly.
If you think a debt consolidation loan is useful to you, it’s a good idea to contact a lender and review the types of personal unsecured loans that they offer. You should then calculate if taking out a loan to repay your current credit card and other lines of debt will work out for you. No matter your current credit score, it’s something worth considering if you’re hoping to get out of debt and regain control of your finances.