Debt consolidation loans

Consolidating all your debts into one loan might appear to make life easier but there might be much better ways of dealing with debts. Find out more about how debt consolidation loans work, then get free debt advice before you make a decision.

• What is a debt consolidation loan?
• When should you consider a debt consolidation loan?
• When getting a debt consolidation loan doesn’t make sense
• Debt consolidation loans that don’t put your home at risk
• Fees and charges for debt consolidation loans
• If you choose a debt consolidation loan

What is a debt consolidation loan?

If you’ve got lots of different debts and you’re struggling to keep up with repayments, you can merge them together into one loan to lower your monthly payments.

You borrow enough money to pay off all your current debts and owe money to just one lender.

There are two types of debt consolidation loan:

• Secured – where the amount you’ve borrowed is secured against an asset, usually your home. If you miss repayments, you could lose your home.
• Unsecured – where the loan is not secured against your home or other assets.

Secured debt consolidation loans

Debt consolidation loans that are secured against your home are sometimes called homeowner loans.

You might be offered a secured loan if you owe a lot of money or if you have a poor credit history.

You should get free debt advice before you consider taking out a secured debt consolidation loan, as they’ll not be right for everyone and you could just be storing up trouble or putting off the inevitable.

When should you consider a debt consolidation loan?

Consolidating debts only makes sense if:

• Any savings are not wiped out by fees and charges.
• You can afford to keep up payments until the loan is repaid.
• You use it as an opportunity to cut your spending and get back on track.
• You end up paying less interest than you were paying before and the total amount payable is less (it could be more if you repay over a longer period).

Before you choose a debt consolidation loan think about anything that might happen in the future which could stop you keeping up with repayments.

For example, what if interest rates go up, or you fall ill or lose your job?

If you can’t stop spending on credit cards, for example because you’re using them to pay household bills, this is a sign of problem debt.

You should get free debt advice before taking out a debt consolidation loan.

When getting a debt consolidation loan doesn’t make sense

A debt consolidation loan definitely doesn’t make sense if:

• You can’t afford the new loan payments
• You don’t clear all your debts with the loan
• You end up paying more overall (due to the monthly repayment being higher or the term of the agreement being longer), or
• You really need help sorting out your debts rather than a new loan - a debt adviser might be able to negotiate with your creditors and arrange a repayment plan.

Debt consolidation loans that don’t put your home at risk

A better option might be a 0% or low-interest balance transfer card.

This is the cheapest way if you repay within the interest-free or low-interest period.

You’re likely to need a good credit rating though to get one of these cards.

You could also consolidate your debts into an unsecured personal loan, but again you’ll need a good credit rating to get the best deals.

• Should you transfer your credit card balance?
• Your credit score and how it can affect the interest you are charged

Fees and charges for debt consolidation loans

Beware of the high fees some companies charge for arranging the loan.

• Read the small print carefully for any extra fees or charges before you sign anything
• Check whether there are any fees for paying off existing loans early as this could cancel out any savings you make
• Avoid paying a fee for a company to arrange the loan on your behalf unless you’re getting advice (and you’re sure it’s worth the cost)

If you choose a debt consolidation loan

• Shop around using comparison websites to find the best deal
• Get advice before you make a final decision. There might be better ways to clear your debts that you haven’t thought about.
• Don’t just look at the headline interest rate. Compare the APR (the annual percentage rate), or the APRC for secured loans, as this will include extra costs such as an arrangement fee.
• Cut up your credit cards to avoid the temptation to keep spending

This article is provided by the Money Advice Service.