What is a debt consolidation loan?
A debt consolidation loan allows you to simplify your finances. If you owe money on multiple cards or are paying back several loans you can consolidate all your payments into one loan, meaning you no longer make multiple payments each month.
Essentially you use the loan to pay off all your existing debts so that you only have to make one repayment a month to the lender you took the debt consolidation loan out from.
Debt consolidation loans fall into two categories: Secured and unsecured.
Secured loans – also known as homeowner loans – are loans taken out against your home. They enable you to borrow larger sums of money but you risk losing your home if you fall behind on repayments.
Unsecured loans – also known as personal loans – are loans which are not taken out against anything. The amount you can borrow will be based on your credit rating and you will not be able to borrow as much as you might with a secured loan, however the lender has no claim on your home should you fall behind on your repayments.
Pros and cons of debt consolidation loans
The main advantage of a debt consolidation loan is that it enables you to consolidate your loans and make one single payment each month, rather than several different ones – less to worry about and less chance that you will forget to make a payment.
It also allows you to close down other credit card and loan accounts, which in turn can improve your credit rating as it demonstrates to lenders that you are taking control of your finances.
However when taking out a debt consolidation loan be aware that you might be paying a higher rate of interest than you need to on some of your borrowing.[j1] There are paths you can take to avoid this, such as choosing instead to move your outstanding balances onto a balance transfer card that has a 0% introductory rate – of course if you are doing this it is very important that you are able to pay off the balance before the introductory period ends, as the interest rate will typically jump to a much higher one when this happens.
You should also be aware that if you take out a secured debt consolidation loan and are unable to keep up with your repayments there is a possibility that you could lose your home. If you find yourself in a situation where a secured debt consolidation loan is the only option available to you make sure you look around for the best deal and have a firm plan in place to keep up with repayments.
Alternatives to a debt consolidation loans
As we have already said, a good alternative to a debt consolidation loan is a balance transfer card. You can take advantage of 0% interest introductory offers by moving multiple debts onto them, giving you a chance to pay your debts off while not having to pay any extra interest for a short period.
However a balance transfer card can only save you money if you use it sensibly. It is really important that you can repay all your debt back before the introductory period ends as the interest rate usually jumps up significantly after this.
Things to remember
Anything that can potentially simplify your finances is always an attractive option, but that doesn’t mean it is the best. There are ways other than a debt consolidation loan to organise your repayments that don’t cost you extra money in interest. You have to consider whether or not paying the extra interest is really worth the convenience, when you could easily spend some time setting up standing orders to reduce the amount of time you spend paying bills each month.
Some debt consolidation loans also carry fees for early repayment – lenders do this to recoup the money they would lose if you are no longer paying interest to them every month. Make sure you check if the debt consolidation loan you are interested in has this charge or not.
Obviously an unsecured debt consolidation loan is safer than a secured debt consolidation loan (for the simple reason that there is no risk in losing your home with the former). However you will only be able to borrow significant amounts of money and be eligible for the best debt consolidation loans if you have a good credit rating. If you have a bad credit rating you can use our comparison tool to find which loans are more likely to accept you and get the best deals.
Is a debt consolidation loan right for me?
Before you do anything make sure to get advice on which type of loan is right for you and use our loan comparison tool to get a good idea of what each loan offers. Use our loan comparison tool to see what each loan has to offer and which one’s you are likely to be accepted by. You should also look at our guides to get a better understanding of the various loans available to you.
As we have said above, a balance transfer card is a viable alternative option to a debt consolidation loan. Just remember that you MUST pay back the balance owed on the car before the low interest introductory period ends.
Debt consolidation loans are attractive options because they offer convenience when it comes to paying back money you owe. However it might be cheaper (and possibly even easier) if you look into other methods to simplify your finances, such as a balance transfer card, as we have mentioned above.