If you’ve got multiple debts, you might have heard of debt consolidation as a way to help organise your payments and perhaps save you money. Placing all your debts into one easy-to-manage monthly payment could make it simpler for you to keep track of what you owe, and can be a relief for people who feel a little overwhelmed. 

However, before you jump into any financial decision, you should make sure that you understand whether it’s right for you. So, what is debt consolidation, and is it the best route for your financial plans? 

What is debt consolidation? 

Debt consolidation is a way that people with multiple debts can simplify their repayments and balances.  

If you owe money to multiple different lenders, you can use a debt consolidation loan to pay off all of those debts at once, leaving you with just one debt to pay off instead. 

Getting all your debts into one place can help in numerous ways, especially if you have several different loans and are struggling to keep track of them all. 

How does debt consolidation work? 

If you have multiple different debts with their own interest rates, repayment days, and loan terms, it can tend to be a little tricky to keep on top of.  

Debt consolidation works by using one larger loan to pay off all the smaller loans that you have. This doesn’t lower the total amount you owe, but it means that you only have one monthly repayment to make. A lot of people find this helpful because it makes it easier to see the total amount you owe and simpler to budget for. It can also sometimes help you get a better interest rate. 

Example of debt consolidation 

The details of a debt consolidation loan will look different depending on your exact circumstances. However, as an example, let’s assume that you have four different debts: 

  • Credit card debt of £5,000 at 35% interest 
  • Personal loan of £5,000 at 12% interest 
  • Overdraft of £10,000 at 40% interest 
  • Store cards of £8,000 at 30% interest 

You could then take out a debt consolidation loan for the full total of £28,000. This would allow you to pay off all of your individual debts, leaving you with just one lump-sum debt of £28,000 to pay off. 

However, it is always worth looking at the interest rates on your debts and the available interest rates for consolidation loans. In this example, if you could get a consolidation loan at 25%, you would end up with a lower interest rate overall. On the other hand, an interest rate of 40% would be higher than your current overall rate. 

On top of this, consolidating your debts can help save you money by changing all your debts into a loan with a set repayment time. Credit card, overdrafts and store cards are ‘revolving’ credit, meaning that even once you pay them off, you still have access to the like of credit. This can lead to continued overspending, which increases how long it takes to pay off, ultimately increasing the amount of interest you will pay. Compared to this, a debt consolidation loan is all about paying off your debt to become debt-free quicker. 

Is it a good idea to consolidate your debts? 

The main reason that people consolidate their debts is to get all of their loans into one manageable agreement, this often means a lower monthly payment and the certainty of a regular outgoing which can help with financial planning and making it easier to track what you owe. If you feel overwhelmed by multiple debts, different interest rates, and payment days, consolidating your debts can help.  

Merging your debts into one can help you feel less stressed and it can make you less likely to miss a payment day – which can help your credit score. 

What types of debt consolidation loans are there? 

Most debt consolidation loans are a type of personal loan. This is likely to be similar to your existing debts. These unsecured loans are not tied to your property or any other asset. If you miss payments on an unsecured consolidation loan, your credit score will be affected. 

It is also possible to get a secured debt consolidation loan. These loans use an asset or property of yours as collateral. The most common secured loans are taken out against your home as with a consolidation mortgage, though you could use other assets such as your car or valuable jewellery. If you fail to meet a repayment on a secured loan, the asset you used as security can be repossessed, meaning that you could be at risk of losing your home. 

What are the advantages and disadvantages of debt consolidation? 

If you are considering debt consolidation, you should consider the benefits and downsides. A lot of these will depend on your exact circumstances, so it is also worth getting professional advice about debt consolidation. 

Advantages 

The main positives that come from debt consolidation are: 

  • It’s easier to track and manage your debts 
  • You no longer have to worry about which debt is a priority 
  • You could qualify for a lower interest rate, reducing the overall amount that you end up paying 

Disadvantages 

On the other hand, debt consolidation can have downsides, such as: 

  • Some of your current loans might have fees for early repayment. This means that you might have to pay a fee to include some of your debts in your consolidation. Secured loans can also have early repayment charges, which can limit how quickly you pay off the consolidated debt. 
  • If you have any interest-only repayment debts, adding these into a consolidation loan will mean you also have to start paying back the principal amount sooner, increasing your current monthly repayments. 

Does consolidating your debt hurt your credit? 

Debt consolidation can lower your credit score. This is because whenever a lender checks your credit history with a hard credit check, your credit score will decrease by a few points. However, this decrease is minimal, and it should be reversed in a few months. This happens because the debt consolidation loan is a new line of credit that you are taking out. 

You could also see a negative impact on your credit score since the new debt will not have any payment history, whereas your older loans will have a good repayment history. Again, this should be a temporary reduction, until you show that you are reliably paying off the new loan. 

Most people find that a debt consolidation loan, which is well managed and replaces their existing credit, rather than in addition to, improves their credit in the long term. This is because consolidation helps people make their repayments on time and stops them from defaulting on any of their individual loans.