Understanding Debt Consolidation Loans
Debt consolidation loans are a way to simplify your finances, by rolling your current debts into one loan. Either in the form of a secured loan or unsecured loan , a debt consolidation loan will generally reduce your monthly outgoings, and ease the stress of dealing with several creditors and juggling multiple monthly repayments. A debt consolidation loan will increase your total amount of debt by spreading repayments over a longer period of time, but will ease the pressure on your finances by replacing several monthly repayments with one lower payment. A carefully managed debt consolidation loan can offer a solution to your financial stress, and provide a way out of the borrowing cycle.
Personal Debt in the UK
Personal debt is at a record high in the UK. Relaxed attitudes to borrowing and poorly informed financial decisions have resulted in a combined total of more than £1 trillion in the UK alone. The average amount of personal debt in the UK is over £4500, excluding mortgages, accumulated through the overuse of unsecured consumer credit such as credit cards, store cards, overdrafts, and personal loans. The number of IVA (Independent Voluntary Arrangement) and bankruptcy applications being made is increasing year-on-year as consumers seek a last resort solution to overstretched finances, despite the long-term damaging effects of such a dramatic step.
The reasons that people find themselves in severe personal debt are many and varied. It may be that a single event causes your outgoings to become greater than your income, such as a relationship breakdown or loss of income. Some people, however, find themselves in substantial debt for no other reason than they like to spend money – even if they haven’t got it.
Being in debt itself is not always a bad thing; borrowing has become a fact of life in the UK, and when used sensibly can be a practical way to pay for expensive purchases such as weddings or a new car, as finding the money upfront is not always possible. However, the relaxed attitude to consumer borrowing in the UK means that many people use credit cards for everyday purchases and do not pay off the balance in full each month, meaning that they routinely live beyond their means.
Is a Debt Consolidation Loan suitable for my situation?
A debt consolidation loan may be a suitable option for your requirements if you fall into any of the following categories:
You are juggling several monthly payments and want to simplify your debts into one monthly repayment
You are struggling to meet your minimum monthly repayments on your credit cards, store cards and personal loans and would like to reduce the amount of your monthly outgoings
You want to reduce the amount of interest you are paying on unsecured forms of borrowing such as overdrafts, credit cards and store cards
Types of Debt Consolidation Loans
A debt consolidation loan can be in the form of either a secured loan or unsecured loan. In rolling up your debts into one large loan you will more than likely reduce your monthly outgoings, and simplify your finances into one monthly payment rather than attempting to keep on top of multiple payments. While this is an attractive option for those struggling to keep their payments under control, a debt consolidation loan must be used carefully in order for you to truly benefit. Rolling your debts into one loan in order to reduce your monthly payments will almost certainly increase your total amount of debt. This is because in order to keep your monthly repayments low, the loan length will usually be increased; and the longer the loan term, the more interest overall you will repay.
Which type of Debt Consolidation Loan is best for my circumstances?
The advantages of a secured debt consolidation loan include:
In return for providing collateral for the loan you may qualify for more attractive interest rates and loan terms. This is particularly important for sub-prime applicants who are considered to be high-risk candidates for a loan
You will generally be able to spread your repayments over a longer period in order to keep your monthly payment as affordable as possible
The disadvantages of a secured debt consolidation loan include:
A longer loan length will generally result in a higher total loan cost; the longer you are repaying a set amount, the more interest you will repay overall
The loan rate is more likely to be variable, which may make controlling your budget more difficult. Your repayments may increase in the event of a Bank of England base rate rise; or if you are late with payments you could be penalised with a rate rise on your loan
If you fail to keep up with your repayments you will be risking your home, as the lender has the legal right to repossess your home in order to settle the loan
The advantages of an unsecured debt consolidation include:
Unsecured loans are commonly available as fixed-rate loans, which gives you greater control of your budget, as the interest rate will remain fixed for the life of the loan, even if rates rise elsewhere.
Greater repayment flexibility is generally available on unsecured loans than on secured loans; the ability to repay early and to make frequent overpayments is important, as overpayments of even just a couple of hundred pounds once or twice a year can make a big difference to the total amount of interest you will repay
Disadvantages of an unsecured debt consolidation loan:
The rate of interest offered by lenders may be substantially higher on an unsecured loan. This is because your credit rating will be considered by potential lenders upon applying for a loan, and your history of borrowing will be taken into account in order to assess the risk you present as a loan candidate. Chances are, by having large amounts of unsecured debt, the interest rate offered to you may be higher than it would otherwise be as you may be considered a sub-prime candidate
What to watch for
Being in the position of needing a debt consolidation loan is not a favourable one. As you may be considered a sub-prime candidate by potential lenders for having large amounts of unsecured debts, your total debt will more than likely increase with a debt consolidation loan. However, if you are struggling to manage your monthly repayments, debt consolidation loans offer the chance to reduce your monthly outgoings into affordable payments. You should be very careful when comparing consolidation loans, and ensure that the total interest you will pay on the consolidation loan will be less than, or at least equal to, the interest you are currently paying by keeping the debts separate. In other words, you should try to avoid consolidating your debts unless you are unable to keep up with your current repayments.
The most important thing to remember when considering a consolidation loan is that clearing your credit and store cards is not a ticket to keep spending. Finding a lender willing to lend to you at a satisfactory interest rate if you have a less than perfect credit history can be hard enough the first time; the second time around you will find yourself in a much more difficult position – especially dangerous if you are struggling with a secured debt consolidation loan, as your home may be repossessed if you fail to complete on your repayments.
Debt consolidation loans are not a magic cure for your debts. Making them work for you takes a commitment to clearing your current debts instead of running up new ones. They can be expensive, but used sensibly, they can be a good way to clear your debts and begin living within your means. Shop around using an independent comparison tool such as the one offered on this site, and find the best option to suit your requirements and budget.
Please note: this website, and the articles and information within it are based on journalistic research. It does not and should not be construed to constitute financial advice. Any information should be considered in regard to specific circumstances. All tips are followed at your own risk and should be followed up with your own research. For more please refer to our terms and conditions of use.