Debt consolidation is when you take out a loan to pay off all your unsecured debts, leaving you with just one fixed payment each month. If you meet your entire repayment schedule (and don’t take out more credit), you can be debt free by the end of your loan’s term.
That can sound very appealing – especially if you feel your debt situation is deteriorating, not improving. However, it’s still a good idea to weigh up the pros versus the cons of consolidation first, before choosing this course of action.
Advantages
There are several reasons this approach can work as an effective solution to settling debts:
- Fixed repayment – If you are clearing debts from multiple sources, your monthly repayments are likely to change, making budgeting difficult. Instead, with just one loan, you’ll know exactly what you have to pay each month.
- Improve your credit rating – It may sound counterintuitive, but your credit rating could improve if you never miss a payment on your new loan.
- Lower monthly repayment – Your new loan could have a lower interest rate than your original debts. It can mean you reduce your monthly repayments as the interest you are charged decreases.
- Easier to keep track – Having just one monthly payment is straightforward so your debt can become more manageable and less stressful.
Disadvantages
The above benefits are compelling, but debt consolidation is not without its drawbacks:
- More interest overall – While you may reduce your monthly repayments, you could end up paying more interest over the life of your loan and be in debt for longer than you would have been otherwise. However, you can get around this by paying off your consolidation loan earlier, in full.
- Loan fees – Taking out another loan to cover old debts will incur fees that drive up the cost of consolidation.
- More risk – Don’t forget that to consolidate with one new loan, you are taking out more debt initially. Plus, if you can’t meet repayments, you will potentially damage your credit score – not improve it. And, if your loan is secured against an asset you own, like your home, you could lose it.
Alternatives to debt consolidation
If the disadvantages are giving you cause for concern, or if debt consolidation is not even an option due to a poor credit score, there are other options you could try.
- Debt charities – You could work with a debt charity such as StepChange or the National Debtline. They’ll give you free and independent advice by looking at your expenditure versus income, before recommending available options.
- 0% Credit Card – You could try transferring debts to a 0% credit card. This keeps your interest to a minimum, so it can be an attractive choice. However, for it to be worthwhile, you need to keep up your regular payments to pay off your debt by the end of the 0% interest period.
- Debt management plans – These are agreements between you and your creditors to help pay off all your debts. You can arrange these plans directly with them or through a licensed debt management company – though this will incur a fee. These plans can only be used to pay ‘unsecured’ debts.