What does it mean and when is it useful?
When you have more than one debt to deal with and you’re looking for change, debt consolidation could be a practical solution. Debt consolidation essentially rolls up all your existing debts into one single account. It is a new personal loan, which means that you borrow money on a loan that you use to pay off other existing and more expensive debts. For instance it is useful if you have expensive debt such as a bad credit loan, especially if your credit score us now better than it used to be. This can make debts easier to manage and faster to pay off. Debt consolidation isn’t always the best solution – it depends on your current situation, as well as the deals that you’re being offered.
The cons of debt consolidation
- There is the potential to get into even more debt. If you’re looking for debt consolidation as an option to help you reduce your debts then be wary. The way that debt consolidation works is to use a new loan to repay old debts. For many people the temptation may then be to spend the debt that has been cleared. So, the worst case scenario is that you have the new debt consolidation loan and then you re-spend on old credit cards or overdrafts too.
- The wrong debt consolidation could be costly. It’s crucial to find a debt consolidation loan that is cheaper than your current debt or it will just cost more. It’s also worth bearing in mind that if the debt consolidation loan is spread over a longer period of time than existing debt you’ll be making more repayments and so paying more.
- There could be consequences. Finding an affordable debt consolidation loan is crucial, as if you can’t make the payments this will be problematic. If the loan is secured on an asset, such as home or car, you may lose this. Problems paying could also affect your credit score.
The pros of debt consolidation
- Paying less interest. The main purpose of debt consolidation is to reduce what you’re paying in interest on existing debts. So, if you can find a debt consolidation loan with a lower interest rate than your current credit cards, personal loans or overdraft then you will pay less overall while you make repayments.
- Reducing the monthly repayment. Another key benefit of debt consolidation is the opportunity to reduce what you pay every month. Many people use a debt consolidation loan to take the pressure off the monthly budget by spreading repayments out over a longer term. If you’re struggling to cover your current outgoings this could make a big difference to your finances.
- Simplifying your finances. Multiple debts can be difficult to juggle. Different payment dates, fees and interest rates can make finances seem very complex when you have a lot of debts that you’re trying to clear. When those debts are consolidated there is just one interest rate and a single monthly payment. So, there’s no risk of missing payments and incurring fees and you’ll always know where you are when it comes to how much you’re paying for what you’ve borrowed.
- Taking control of your debts. If you’re feeling overwhelmed by debt and you’re keen to pay off what you owe, debt consolidation can be a good first step that enables you to take control.