Why debt consolidation is not the answer
Debt consolidation loans promise the world, but they may end up making your debt problem worse.
There are lots of tempting offers that we see each day, inviting us to consolidate our debts into one easy payment. These are especially enticing this month as the post-Christmas credit card statements hit the welcome mat.
The offer sounds good. You can:
- ‘Clear all your debts today with one easy monthly payment’
- ‘Get a fast pay out, whatever your credit history’
- ‘Apply online now for a quick decision’
Why wouldn’t you want to consolidate your loans after reading that?
It’s because of the blanket advertising that we often get questions about what is the best way to consolidate debts or how to go about it. However we don’t tend to recommend it as a debt reduction option, for one very good reason.
It very rarely does what you think it will.
What is debt consolidation?
Let's start by taking a look at exactly what debt consolidation is, and how it works. A debt consolidation loan is where you take out one large loan to pay off your existing individual debts.
It can make life easier in that you only have to make one monthly payment, rather than a number of different payments at different times in the month.
And it might reduce the amount that you pay out monthly. However, you are likely to be paying more over a longer term (when you include the interest).
Why is debt consolidation unlikely to the best solution?
There are many reasons:
- Lenders often offer a consolidation loan on the proviso that it is secured against a property. This increases the likelihood of them lending to you as it limits their risk. However this means that your house is at risk if you are unable to maintain the repayments.
- Often people that are looking for consolidation loans have already maxed out their current borrowing facilities. This can mean that access to further credit is limited. For more on the importance of credit records, and keeping yours as clean as possible, be sure to read What REALLY damages your credit rating.
- Although the monthly repayments can be more manageable, you’re actually repaying much more through interest payments.
- Consolidation loans can be marketed as a debt ‘solution’, although as it means taking out more credit this doesn’t make sense!
- The temptation is there to re-use the old credit cards included in the loan. This can escalate the scale of the debt problem very quickly, so it’s really important that all old accounts are closed, and not just cut up, to remove the opportunity entirely.
What you should do instead
In some very rare instances a consolidation loan can be a viable option. However if you’re thinking about taking one out you should consider your financial situation first and contact us for advice.
- Put together an effective and realistic budget. Don’t forget to put aside for costs that aren’t monthly, such as car MOTs or visits to the dentist. Use an online budget planner to help you.
- Don’t over-commit and borrow more than you can afford. Use your budget to help you work out how much surplus money you have.
- Is there an option of a 0% balance transfer instead? If it’s the interest that’s unmanageable switching to a credit card with zero interest could be a better option (but remember to cut up any old cards and close the accounts). Check out There's never been a better time to get a credit card for more.
- Ensure that you’re applying for a consolidation loan and not a fee-charging debt management plan (Follow the link for more on debt management plans). These are two different things, and a DMP with a fee-charging company could cost you just as much - if not more - in charges.
- Consider your local credit union instead. These aren’t just for savings; they can sometimes provide low interest rate loans too
We’ve produced a guide to debt consolidation, available on our website now.
If you’re considering debt consolidation as an option try our online debt counselling service CCCS Debt Remedy first, as there will almost certainly be more appropriate solutions that you may not have thought about.