Rachel Wait

If you have debt in multiple places, consolidating that debt into one loan can make it much easier to manage and potentially save you money too.

But before you apply for a debt consolidation loan, it’s important to understand how they work and what to be aware of.

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What is a debt consolidation loan?

A debt consolidation loan lets you combine existing debts into one place. Let’s say you’ve borrowed money on a store card, a credit card and a personal loan. This means you have three separate monthly repayments to make – which will likely all be different amounts – and potentially three different lenders to deal with.

By consolidating that debt into one new loan, you make a single monthly payment to one lender. This can make it much easier to keep track of how much you owe and if your new loan has a lower interest rate, it could work out cheaper too.

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Types of debt consolidation loans

There are two main types of debt consolidation loans – secured and unsecured.

A secured debt consolidation loan is secured against an asset, often your home. Because of this security, you can typically borrow a larger sum of money over a longer term (up to 25 years or more), and interest rates tend to be lower too. You may find it easier to get accepted for a secured debt consolidation loan if you have poor credit.

However, because you’re securing the loan against an asset, that asset is at risk if you fail to keep up with your repayments. So, you need to consider this type of loan carefully. If you can’t meet your repayments, the lender has the right to take ownership of your home and sell it to recoup its money – though this is usually a last resort.

An unsecured loan, on the other hand, is lower risk as you don’t need to use an asset as security. However, this means you typically can’t borrow as much as with a secured loan and rates tend to be higher. You can usually borrow over a term of between one and seven years.

With an unsecured loan, the amount you can borrow and the interest rate you are offered usually depend on your credit history - the higher your credit score, the better your chances of securing a competitive deal.

How does a debt consolidation loan work?

If you apply for a debt consolidation loan, your first step is to work out how much you need to borrow by calculating the total cost of your existing debts.

Once you have this figure ready, you can apply for a loan for that amount. If the lender agrees to let you borrow, you receive the loan funds and use those to pay off your existing debts. You won’t reduce the amount of borrowing you have, but you’ll now have one repayment to make each month, rather than several.

You’ll start making your new monthly repayments as soon as your new loan is in place. It’s important to make these on time, so it can be worth setting up a monthly direct debit to ensure you don’t miss any.

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What debts can you consolidate using a loan?

You can consolidate a range of existing debts into one loan, such as:

·   Personal loans

·   Credit cards

·   Store cards

·   Overdrafts

·   Payday loans

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What are the benefits of using a debt consolidation loan?

Some of the main benefits of using a debt consolidation loan are as follows:

·   Easier to manage: You only have one monthly repayment to make to one lender, so it’s easier to keep track.

·   Potentially cheaper: If your loan has a lower interest rate, you could save money on your debt repayments.

·   You could pay off your loan faster: Reducing your interest rate could help you pay off your debts faster.

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What are the potential drawbacks?

Before deciding whether a debt consolidation loan is right for you, you should also consider the downsides:

·   You could end up paying more: If your new loan has a higher interest rate, or you choose a longer repayment term, your debt could become more expensive.

·   Fees may apply: You may need to pay an early repayment charge to pay off an existing loan early, and your new loan may come with an arrangement fee.

·   You’ll need to undergo a credit check: When you apply for a loan, you’ll need to undergo a hard credit check which will be noted on your credit file.

·   Secured loans come with risk: If you use an asset as security, it could be at risk if you fail to repay the loan.

·   You could get trapped in a debt cycle: If you continue to borrow while repaying your debt consolidation loan, you could get into financial difficulties.

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How much does a debt consolidation loan cost?

The cost of your debt consolidation loan depends on several factors, including:

·   The annual percentage rate (APR): This refers to the total cost of your borrowing for a year, including interest and fees. The lower this is, the less it will cost you.

·   The term of the loan: Borrowing over a longer term lowers your monthly repayments but you end up paying more in interest.

·   Your borrowing amount: Naturally, the more you borrow, the more the loan will cost.

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Should I apply for a debt consolidation loan?

Before applying for a debt consolidation loan, consider whether doing so will save you money overall.

To do this, you need to first check if any early repayment charges apply to your existing debts. You should be able to find this information in the terms and conditions of your loan or give the lender a ring to ask.

If you do need to pay early repayment charges, be aware these may outweigh any savings you’d make by consolidating your debt.

Next, add up the total cost of your current debts, including early repayment charges, to calculate how much you need to borrow. Then start comparing loans to see whether you’re likely to be able to borrow that amount.

You also need to consider how long you need to repay the amount borrowed. You may need to borrow over a longer term to make your monthly repayments more affordable. But this means you’ll pay more in interest overall, making your debt more expensive.

If you work out that consolidating your debts into one new loan will result in more manageable monthly repayments, and the total amount you’ll repay with the new loan is less than the total amount payable on your existing debts, it could be worth taking the plunge.

But if you’ll end up paying more than if you kept the debt where it is, or you don’t think you would be able to afford your new monthly repayments, a debt consolidation loan is unlikely to be a good choice. It may not be the best decision if you’re close to settling your existing debts either.

If you are struggling to keep up with your existing debt repayments, it’s important to speak to your lenders as soon as possible. They may be able to come up with a more manageable repayment plan to help you, without the need to take out a new loan.

You can also seek free advice from debt charities, such as National Debtline, StepChange and Citizens Advice.

Can I get a debt consolidation loan with bad credit?

If you have poor credit, you’ll likely find it harder to get accepted for a debt consolidation loan. But it is still possible. Just be warned that the interest rate you pay will be higher, making the loan more expensive. You might not be able to borrow as much as you’d hoped either.

If you have bad credit, you may find it easier to get accepted for a secured loan – but remember this means using an asset, such as your home or car, as security. Should you fail to repay your loan, that asset could be at risk.

For these reasons, you should think carefully about consolidating your debt if you have poor credit. Taking out a new loan could cause your credit score to dip further, and you may find that it ends up working out more expensive if you’re paying a higher interest rate.

Crucially, you need to be confident that you could comfortably afford to meet your new monthly repayments. If you can’t, you risk doing further damage to your credit rating, and you could end up making your debt situation worse.

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How to compare debt consolidation loans

If you’ve decided to apply for a debt consolidation loan, we can help you compare your options from over 30 credit providers and banks.

You can select how much you need to borrow and for how long, then start your free search to receive personalised offers without affecting your credit score. We’ll only carry out a soft credit check which won’t leave a mark on your credit record and enables you to see how likely you are to be approved for a loan.

Be sure to compare factors such as the interest rate, fees, the length of the loan and the amount you can borrow to help you decide which option is right for you.

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Loans are a popular way to borrow cash. They can be used to help fund the cost of a large purchase, such as a new car, help you pay for a wedding, or even consolidate existing debts into one manageable monthly repayment.

How do loans work?

When you apply for a loan, you receive a lump sum of cash that you then repay in monthly installments over a set term.

If you’re applying for an unsecured loan, where you don’t need to use an asset as collateral, terms usually range from one to seven years, and you may be able to borrow between £1,000 and £25,000. Because the interest rate is typically fixed, you’ll know exactly how much you need to budget for each month.

A secured loan, on the other hand, lets you borrow a larger sum of money over a term of 25 years or more, but you must secure your loan against an asset such as your home or car. This asset is then at risk if you fail to meet your monthly repayments. Secured loans can come with fixed or variable interest rates.

Applying for a loan is a big financial commitment, which means it’s important to consider the factors below before deciding whether a loan is the right choice for you.

1. What do you need the loan for?

First, think about what you need the money for - this can help you establish whether a loan is the best way to borrow the funds you need.

Generally, loans are a good option for covering one-off purchases or funding projects such as major home improvements. But if you’re looking to cover emergency expenses or need to borrow smaller sums more regularly, other borrowing options such as a credit card are likely to be more suitable.

2. How much can you afford to repay each month?

It’s crucial to have a good understanding of how much you can afford to repay each month.

To do this, go through your bank statements and work out how much money you have coming in each month from your salary and any other income, and how much you spend on household bills and other expenses. This should give you a clear idea of how much money you have left over each month and how much you could afford to put towards loan repayments.

It’s important not to overstretch yourself financially because missing loan repayments can damage your credit rating and make it harder to get credit again in the future. Increasing the term of the loan can lower your monthly repayments, potentially making them more affordable, but bear in mind this means you’ll pay more interest overall.

3. Do you have good credit?

If you haven’t checked your credit record for a while, now’s the time to do so. Having a good credit score increases the chances of getting accepted for a loan, and it also means you’re more likely to qualify for a lower interest rate.

By contrast, if you have poor credit, you might find it harder to get accepted for a loan – you’ll certainly have fewer lenders to choose from and you’re likely to pay a higher interest rate, making your borrowing more expensive. You might also be offered a smaller loan amount than you were hoping for.

You can check your credit record for free with any of the three main credit reference agencies – Experian, Equifax and TransUnion. As well as looking at your credit score, you should check your report for any errors. Even simple things like a mistake in your address can affect your chances of getting credit. So, if you spot anything, contact the credit reference agency and ask for a correction.

4. Secured or unsecured?

Another important consideration is whether you want to apply for a secured or unsecured loan.

As mentioned, a secured loan requires you to use an asset – usually your home – as security. This means the lender has the right to repossess that asset if you fail to repay your loan. This increases the risk for you, the borrower, but lowers the risk for the lender. As a result, lenders tend to offer higher loan amounts for secured loans, and you’ll usually get a better interest rate too. This makes them more suitable for larger home improvements, such as an extension.

Secured loans tend to be easier to qualify for, which means you might want to consider one if you have bad credit. But if you do apply for a secured loan, it’s crucial to make sure your repayments are affordable.

Unsecured loans, on the other hand, don’t ask for security, making them less risky for the borrower. However, as the risk is higher for the lender, you’ll need a good credit score to qualify for the best interest rates, and you won’t be able to borrow as much as with a secured loan. Unsecured loans can be a good option for buying a car, paying for a wedding and consolidating debt.

5. What’s the cost of the loan?

When comparing loans, it’s important to consider the total cost of the loan, including whether there are any arrangement fees to pay, or whether you’ll be charged an early repayment fee if you decide to pay back your loan before the end of the term.

You also want to check whether the interest rate is fixed or variable. Unsecured loans typically offer a fixed interest rate, meaning your monthly repayments remain the same for the duration of the loan, and you can budget accordingly.

Secured loans may have variable interest rates, which means the interest rate and your monthly repayments could go up or down during the loan term, making it harder to determine the overall cost of the loan.

How to improve your chances of getting a loan

Before applying for a loan, it’s worth making sure your credit score is as good as it can be. You can do this by:

• Checking you’re registered on the electoral roll – lenders use this to verify you are who you say you are
• Paying bills and other credit repayments on time
• Paying down any existing debts.

It’s also best to space out credit applications by at least three months, preferably six. That’s because each time you apply for credit, like a loan, a hard credit check is carried out and this leaves a mark on your credit file. If you have a lot of hard searches on your credit file in a short space of time, lenders may believe you are struggling to manage your finances and may not let you borrow.

When you compare loans through us, we initially carry out a soft credit check that leaves no mark on your credit file and won’t hurt your credit score. This allows you to see which loans you’re more likely to qualify for, helping you to apply for your chosen loan more confidently.  

What are the alternatives to a loan?

If you don’t think a loan is the best choice for you, some of the alternative options include:

• ‍An overdraft: If your current account offers an arranged overdraft, you could use this to cover emergency expenses or other unexpected costs. However, overdrafts should only be used for the short term, as interest rates are generally a lot higher than loan rates.‍
• A credit card: Credit cards can help you spread the cost of a holiday or a one-off large purchase. You won’t be able to borrow as much as you can with a loan, but if your credit card offers a 0% purchase deal, you can avoid paying interest on your repayments for several months.‍
• Savings: If you have built up a savings pot, you could use these funds to cover an unexpected bill, such as car repairs, or even to pay for a holiday. You’ll then need to take steps to replenish your savings.

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