Will A Debt Consolidation Loan Save Me Money?

How hard do you find it to keep track of all your financial comings and goings? Juggling your budget to make sure there’s always enough money in your account when payments are due to come out is a job with little room for error. Missing a payment or accidentally going overdrawn can result in fees and charges that can be hefty… there has to be an easier way to manage it all, right? If you’re looking for a way to combine your monthly outgoings into one payment, then you may be interested in a debt consolidation loan.

What is a debt consolidation loan?

A debt consolidation loan allows you to borrow enough money to pay off your debts, then only owe money to the new lender. It doesn’t automatically reduce the amount of money you owe, but you could save money on interest and charges if the interest payable on your new loan is less than on your other debts combined. Lower interest can also mean lower monthly payments. So a debt consolidation loan could help you free up some money in your budget, too.

Is a debt consolidation right for me?

There are a few things you should consider when deciding whether a debt consolidation loan is the best choice for you:

• What kind of debts do you have? Debt consolidation loans can be used to consolidate your monthly payments for personal loans, credit cards, overdrafts, utility bills, tax arrears, and money owed to a debt collection agency. They can’t normally be used to consolidate mortgage payments and some types of car finance, so check this first if you want to include them.
• Will all of your debts be included? The idea of a debt consolidation loan is to help you repay your debts and simplify your finances at the same time. If a debt consolidation loan won’t cover the full amount you’ve borrowed elsewhere and you’d still have to make separate payments as well, then you may want to consider whether it’s right for you after all. It’s worth bearing in mind that if you have some debts that you’re very close to paying off, it may be better to keep these separate as consolidating them could lead you to paying more in interest.
• Do your lenders charge early payment fees? Some lenders charge a fee to customers who want to settle their balances early. Check the small print of your agreements to find out if this applies to you, and factor it in when making sure that a consolidation loan definitely works out cheaper for you.
• Can you afford the monthly payments on the debt consolidation loan? It’s important that you can afford the new monthly payment for your consolidation loan, even if your circumstances change.

What types of debt consolidation loans are available?

There are two kinds of debt consolidation loan:

• Secured – the amount you borrow is secured against an asset you own. This is usually your home, which is why these loans are sometimes called homeowner loans. Because the loan is secured against your property, the interest rates available can make borrowing cost effective versus sticking with all your original lenders.
• Unsecured – often called personal loans, these loans are not secured against an asset. Because the money is lent in good faith, unsecured loans usually come with higher interest rates, and in smaller loan amounts than secured loans.

Which types of loan are available to you will be determined by the size of your debt, and your financial circumstances. Secured loans may be more accessible to those with particularly large debts, or low credit scores, but there are specialist unsecured lenders who can help people in these situations, too. If you take out a secured loan, then you need to be certain that you’ll be able to keep up with your payments, otherwise your home will be at risk.

How will a debt consolidation loan affect my credit score?

What impact a debt consolidation loan has on your credit score really depends on your circumstances. If your score goes down, then this could be because of your credit utilisation. Credit utilisation is the amount of credit you’re using as a percentage of all the credit available to you across your various accounts. As you use your debt consolidation loan to pay off each of your debts and the accounts are closed by your lenders, then the total amount of credit available to you will decrease. Logically, then, the percentage of your available credit that you’re using will increase. High credit utilisation can be a cause for concern for lenders, as it indicates you may be dependent on the credit you have. So, it impacts your credit score negatively. This is nothing to worry about, though, as your score will bounce back in time.

Consolidating your debts can make them easier to manage: fewer payments to make each month means less chance that one of them will be forgotten! Making your payments each month won’t increase your score by itself, but forgetting to make a payment on time would definitely cause it to drop. So, while a debt consolidation loan isn’t something that will actively boost your credit score, simplifying your payments can help to prevent it from falling as it would if you forgot about a payment that was due.

As with any type of borrowing, if you fall behind on payments towards a debt consolidation loan, then your credit score will be negatively impacted. Depending on whether you’ve taken a secured or unsecured debt consolidation loan, you could also lose your home if you’re not able to get back on track or come to an alternative arrangement with your lender.

Are there alternatives to a debt consolidation loan?

If your circumstances allow for it, then you may find that you can consolidate your debts without having to take out a debt consolidation loan. For example, if you only owe a relatively small amount, then you may be able to use a balance transfer credit card to consolidate your debts, and maybe benefit from 0% interest for a period of time. It’s important to remember, though, that unless you repay your full balance during the 0% interest period, you will be charged interest on anything that is still outstanding when the interest free period ends.

If you feel that no type of consolidation loan could get your debts back under control or reduce your monthly outgoings as much as you need, then you may want to consider seeking free and impartial advice from a not-for-profit service like the Money Advice Service, or StepChange. There is always a way to get your finances back on track, and their debt advisers will be able to help you take stock of your situation and guide you through the options available to you.