What is Debt Consolidation?
February 5, 2015
What is Debt Consolidation?
Debt consolidation combines various debt payments into a single monthly repayment. It is designed to make your total debts more affordable, and their management easier. A debt consolidation loan can be a good idea in some circumstances, but there are also instances where a different solution might be preferable.
People who make only the minimum payment each month on credit card borrowing will naturally build up significant amounts of debt over time. This is one of the most common ways that debt spirals out of control, and in this instance debt consolidation may be a good idea.
In some cases it may be more beneficial to look for a 0% interest credit card that will accept balance transfers rather than taking out a consolidation loan, but this depends on the credit and store cards involved and amounts owed.
The difference between debt consolidation and debt management
In essence, debt consolidation involves applying for new borrowing in order to repay existing debt that often involves credit cards and store cards. The full amount of debt will still be owed.
Debt management means agreeing a course of action with your creditors to make reduced repayments for a longer period of time, and creditors generally receive a proportion of the debt rather than the full amount.
A money advisor or insolvency practitioner can provide clarity on debt management and debt consolidation issues, making sure that you choose the best route for your circumstances.
What should you do before applying for a debt consolidation loan?
Getting to grips with how much money you owe is often very sobering, and not a little frightening, but the first step to take is to look at all your paperwork and calculate exactly how much you owe.
Only by finding this out will you know if debt consolidation is going to be the most appropriate route. Once the total debt has been established, you will need to make a detailed monthly budget that includes all regular outgoings, however small.
In the interests of accuracy, the best way to make a reliable budget is to keep receipts for everything you spend during a month, or note down the details of your spending. Once you have paid all the essential household bills (without including the existing unsecured debt repayments), any money remaining can go towards repaying existing borrowing or paying off a new consolidation loan.
If you have any savings, some or all of them may be better spent on paying off existing debt, especially as credit interest rates are currently so low. One of the dangers of consolidating your debts is the temptation to borrow more than is necessary when taking out the new loan, so this is also something to watch out for.
It is worthwhile checking your credit rating, as this will affect whether you are offered a secured or unsecured consolidation loan. Secured loans are often offered to people with a poor credit history, but caution should be taken because the loan will be secured on your home. Other criteria that lenders consider include the size of the loan requested and your repayment history.
Early repayment charges may apply on some of the existing borrowing, so don’t forget to check for these and include them in the new loan amount if applicable.
What are the advantages of debt consolidation?
- Interest rates may be fixed at a lower rate than you are currently paying.
- It can relieve the stress of repaying numerous unsecured loans or credit card borrowing, and trying to keep track of various rates on different cards.
- Your credit rating may improve if you manage to pay off the loan without any problems.
- Payment amounts can be reduced.
- If you can budget effectively, it may be a good way to rid yourself of debt.
- Having a single repayment can focus your mind and help you keep track of the total debt owing, rather than feeling overwhelmed by the sheer number of lenders chasing you for money.
- Credit and store card accounts can be closed down if repaid in full using a consolidation loan – this avoids temptation in the future.
Are there any disadvantages?
- Taking out new credit in addition to the debt consolidation loan would mean that debts could spiral again.
- Debts will take longer to repay.
- The total amount of interest paid may be more than before consolidation, due to the extended period of time taken to repay.
- It can be difficult to judge how much is affordable, particularly if you are facing redundancy or other uncertainties in employment.
- Debt consolidation options are not backed by the government.
Take care if you are offered a secured consolidation loan
A secured loan means that your home will be at risk should you default on payments. These loans are generally offered if large amounts of debt are involved, and although they usually attract a lower rate of interest, this is because the risk to the lender is considerably reduced as they have recourse over your property.
Unsecured consolidation loans do not involve your home, and may be a good idea for people aware of how much they can afford each month, and who are aiming to rid themselves of debt for the long-term.
It is also advisable to think carefully about taking out a consolidation loan if all your debts will not be included in the new loan. If this is the case, you will still need to monitor interest rates and make more than one monthly payment, which may defeat the object of taking out this type of loan.
Seeking guidance from a qualified money advisor is the best way to ensure you are doing the right thing. They may be able to offer alternatives previously unconsidered, or at least help you become more confident in your own mind that debt consolidation is the best route to take.
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