Our Guide to How Debt Consolidation Works

Love Debt Free How does debt consolidation work
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If you owe money to lots of different creditors, it is easy to feel overwhelmed as you try to keep track of your different accounts.

By moving all of your debt to one place, you may make it easier to stay on top of your finances and manage your debts.

This is known as consolidation your debt, and in the right circumstances, debt consolidation can be a valuable tool on the road to regaining financial freedom. 

How Does Debt Consolidation Work

When you consolidate debt, you move all of your loans into one account. Instead of making lots of smaller payments to many different lenders, you just make one single payment into one account every month.

In this way, it can be a useful tool in tackling debt which is starting to become a problem. It makes it easier to manage your payments and know exactly how much you need to budget every month to pay off your debts.

It can also make it more straightforward to find out what you still owe, as you slowly start to reduce the payment on your account.

There are a couple of different ways you can consolidate debts. The most common is to use a debt consolidation loan, which is a kind of personal loan.

Debt Consolidation Loans

When you take out the loan, you use the money to pay off all of your other debt accounts and then start making regular payments into that account instead.

It is normally possible to spread debt consolidation loans and personal loans over several years. This can help to reduce the cost of your monthly payments

For example, if your minimum monthly payment towards a total of £4000 debt on credit cards, store cards and overdrafts is £200, you don’t have the option to reduce how much you pay each month without defaulting on the accounts.

However, by consolidating this debt into a personal loan, you could spread the payment out over a longer period of time. With an interest rate of 10%, you would pay £185 per month if you spread the loan over two years, or £129 over three years.

This can be great if you are struggling to afford your monthly minimums. However, the longer you borrow for, the more interest you will pay overall.

You should also consider whether you would be able to afford the loan if your financial circumstances were to change. The longer you are in debt, the more chance there is that you could experience a change in personal circumstances.

Unsecured v. Secured Consolidation Loans

When you take out a personal debt consolidation loan, you can choose between borrowing on a secured or unsecured basis.

Unsecured loans use your credit rating to determine how much interest you will be charged, and have a borrowing limit of £25,000. If you have a low income or a bad credit rating, you could find it hard getting approved for an unsecured loan.

However, this is generally considered to be a safer way to borrow because if you default, your lender does not have the automatic right to repossess your belonging. Unsecured loans use your credit rating to determine how much interest you will be charged, and have a borrowing limit of £25,000.

If you have a low income or a bad credit rating, you could find it hard getting approved for an unsecured loan. However, this is generally considered to be a safer way to borrow because if you default, your lender does not have the automatic right to repossess your belonging.

If you need to borrow more than £25,000 or if you have a bad credit rating or low income, you may consider taking out a secured consolidation loan. This kind of loan is secured against the value of your assets, such as your car or home.

This kind of debt is safer for the lender because if you default, they have the right to repossess your belongings and sell them to recover their losses.

As a result, it is possible to get lower interest rates on secured loans because the lender considers them to be less risky. However, the risk for the borrower is higher, because if they default they stand to potentially lose their home.

In either case, if you don’t keep up with your loan repayments, you could land yourself in financial difficulty, for this reason, it is important to think carefully about whether debt consolidation is the right solution for you. If you are not sure, you may consider seeking independent advice from a debt counsellor.  

0% Interest Balance Transfer Credit Cards

If you have a relatively small amount of debt and a reasonable credit score, you could consider using a 0% interest balance transfer credit card.

This allows you to move your debt balances onto a credit card, on which there is no interest charged for a set amount of time. This can be for up to 18 months. If you pay off your debts before the end of the interest-free period, you could save a lot of money by not paying interest.

However, these cards sometimes have fairly high-interest rates after the introductory period ends, so you should factor this in before you sign up and make sure you can afford to pay off or significantly reduce your debt before you start being charged interest.

How Much of a Burden Is Your Personal Debt?

YearHeavy BurdenA bit of a burdenNo problem at all
2010 – 201220%36%44%
2012 – 201420%33%46%
2014 – 201617%32%52%
2016 – 201814%30%57%

When Does It Make Sense?

Debt consolidation can be a fantastic tool to manage your money and regain a sense of control over your financial life. However, it is not the right solution for everyone, and it has the potential to make your debt problem worse if it’s not used properly.

For debt consolidation to be a sensible choice, you must:

  • Be able to borrow enough to pay off all of your debts, and
  • Payless per month (and ideally overall) than you were before

If debt consolidation would mean that you end up paying more each month, or significantly more overall, then it is probably not the right solution for you and could risk making your debt grow.

Do Consolidation Loans Hurt Your Credit Score?

Whenever you borrow money from an official source, it gets recorded on your credit report. This means that if you take out a debt consolidation product, other lenders will be able to see it on your file.

However, if you make repayments on time and don’t default on your loan, then there should be no reason for this to negatively affect your credit rating.

As with all debts, if you are late to make payments or default on your account, then your credit rating is likely to be harmed. For this reason, it is important to think carefully about whether debt consolidation is the right option for you before you decide to take on extra debt.

Percentage of Debtors Who Find Debt Repayment to Be a Heavy Burden, by UK Region

RegionPercentage
North East15%
North West14%
Yorkshire and the Humber14%
East Midlands13%
West Midlands15%
East of England10%
London22%
South East12%
South West11%
Wales12%
Scotland8%
Source: Office of National Statistics

Can I Get a Debt Consolidation Loan With Bad Credit?

If you have a bad credit rating, you may find that many lenders are unable to offer you a loan which is affordable or reduces the amount you pay each month.

However, it may still be possible for you to consolidate your debts with a secured loan, or by asking a guarantor to co-sign your loan.

You should think carefully about the risks of borrowing with a secured loan, as if you default on your repayments you risk losing your home or vehicle.

Similarly, if you don’t keep on top of your payments with a guarantor loan, the person who co-signed could face serious financial consequences.

Pros and Cons of Debt Consolidation

ProsCons
It can make managing your monthly payments simpler and makes it easy to track your progressYou could end up paying more overall if you spread your payments out too much
You could save money by ditching higher interest rates for a better dealIf you don’t rethink your spending habits, debt consolidation on its own may not be enough to solve your financial problems
You only need to deal with one creditor rather than lots of different ones

How Can Love Debt Free Help?

Here at Love Debt Free, we have partnered with some of the UK’s leading Debt help companies.

They have already helped thousands of people reduce and manage their debts, and they can do the same for you.

Choosing an independent adviser means they won’t recommend a scheme unless they are sure it is in your best interests. Their advice is also regulated by the FCA, which gives you an additional layer of protection.

If you would like to speak to one of these debt help companies, click on the below and answer the questions.

Len Burgess
Len Burgess
Len Burgess is a successful digital entrepreneur and founder of LBLK Publishing which specialises in Financial content. Len has been writing professionally on financial and business topics for 5 years before starting Love Debt Free.
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