Consolidating all your debts into one loan might appear to make life easier, but more often than not it’s a bad idea. If you miss repayments on a secured debt consolidation loan, you could lose your home.
If you’re seriously considering a consolidation loan, you may already be struggling with debt.
You may feel you don’t have many options, but there may be more than you think. There are several debt advice charities that can give you free advice to help you improve your debt situation.
If you’ve got lots of different debts and you’re struggling to keep up with repayments, you can merge these together into one loan as a way of potentially lowering your monthly payments. These loans are usually secured against your home although some lenders do offer unsecured consolidation loans, but for smaller amounts.
With a consolidation loan (which can be secured or homeowner loans) you borrow enough money to pay off all your current debts and owe money to just one lender.
Be careful though, as consolidation loans can be dangerous and lead to more debt.
They were heavily marketed in the years leading up to the financial crisis, but are much less common now. Even if you decide you want one, you may struggle to find someone who will lend to you.
Debt consolidation only makes sense if you use it as an opportunity to cut your spending and get back on track, you can keep up the payments until the loan is repaid and you can afford to pay off any fees or charges to your old lender(s).
A debt consolidation loan only makes sense if:
Even then, you need to consider the potential downside of putting your home at risk remember, your circumstances might change in the future) and the temptation to carry on spending.
Here’s an example of when a debt consolidation loan would make sense (figures correct as of 1 June 2012).
Steve owes £10,000, made up of:
Steve pays a total of £435.83 in interest and fees each month. If he sticks with his current loans it will cost him £4,145.99 in interest and fees to pay off his debt.
If Steve switched to a debt consolidation loan he would only pay 12.6% interest. It would cost him £3,529.30 in interest to pay off his debt, rather than £4,145.99. So Steve would save money by switching.
A debt consolidation loan definitely doesn’t make sense if:
the interest rate means your monthly repayment will be more than what you’re paying at the moment.
You could also consolidate your debts into an unsecured personal loan, which doesn’t put your home at risk. Again, you will need a good credit score to get a low interest rate.
This article is provided by the Money Advice Service.