What is Debt Consolidation?
If you have a significant amount of debt, chances are it isn’t all in one place. Perhaps you’ve taken out loans to prevent late payment charges and still not fully repaid those loans. Interest rates are really starting to squeeze your monthly budget and you may even be finding it hard to keep on top of all of your payments that are due…
Debt Consolidation can combine all of your various debts into one single loan, making your debts much easier to manage in the short term. Rather than making multiple payments each month, you’ll make a single, affordable monthly repayment towards all of your debts.
While it may seem like an answer to all of your problems, there may be better debt solutions available for you, depending on your personal circumstances.
What’s the difference between debt consolidation and debt management?
Debt consolidation and debt management may sound similar, but the two terms refer to two very different methods of dealing with debt.
Debt consolidation essentially involves applying for new credit, known as a debt consolidation loan, in order to repay existing debt. This might include personal loans, overdraft, store card or credit card debt, for example. You will still have to pay off all of your original debt and you may incur additional charges for taking out a new loan, as well as ‘early repayment’ charges if you use a debt consolidation loan to repay certain types of debt before they are due.
Debt management, on the other hand, means reaching an agreement either directly with your creditors or with the help of an insolvency practitioner to make smaller payments over a longer period of time.
While you can read more about the benefits and drawbacks of debt management plans here, a licensed insolvency practitioner will be able to provide clarity and help you find the best solution for your debt problems.
What are the advantages of a debt consolidation loan?
- You may find interest rates fixed at a lower rate than you are currently paying. This may mean that you repay less overall.
- All of your debt will be in one place. This can reduce stress and help you keep track of the total debt that you owe.
- You may be able to improve your credit rating if you are able to pay off your debt without any problems.
- You’ll be able to close any credit card and store card once they’ve been paid off in full using your debt consolidation loan. This will remove any future temptation.
What are the disadvantages of a debt consolidation loan?
- If you still struggle to budget for your single monthly payment you may find yourself in an untenable financial situation again further down the line.
- Your debts may take longer to repay so the total amount of interest that you pay may be higher.
- You may face early repayment charges on certain loans (e.g. mortgages) which will increase the amount that you owe.
- A debt consolidation loan doesn’t necessarily remove the underlying cause of unmanageable debt. If you don’t immediately close your credit and store cards you may be tempted to use them again. This will allow you to increase your overall debt and you will find yourself in a much worse situation than you had been previously. You may still need to take advice on how to budget and live within your means.
Is it a good idea to consolidate debt?
Before settling for debt consolidation, you should first establish how much you owe, as well as your total monthly incomings and outgoings. Once you have calculated any necessary expenses, the rest of your money should go towards paying off existing debts. If you have any savings, you should probably use these to pay off your debt. If you decide to consolidate your debt, you should be wary of borrowing more than is necessary when taking out a new loan, as you may find that your debt begins to spiral again.
It is a good idea to check your credit rating before you apply for a debt consolidation loan, as this will affect the type of loan that you are offered. If you have a poor credit history, you may be offered a secured loan. This is something to be mindful of, as the loan will be secured against your home.
You should also be aware of any early repayment charges that may apply to your existing borrowing before you take out a loan. This might apply on a mortgage, for example, and is a way for the lender to recoup some of the lost interest if you repay the loan early. If you decide to press forward with debt consolidation, this is an extra cost which will have to be factored in to your new loan amount.
Do consolidation loans hurt your credit score?
If you manage to keep up to date with all your repayments, your credit score won’t be affected by taking out a debt consolidation loan. It may even improve your credit score in the end if it makes your debt more manageable. However, if you fail to meet any of the required monthly repayments on your new loan this will be recorded on your credit file.
Can I get a consolidation loan with poor credit?
If you have a poor credit history, whether it’s previous missed payments, defaults, or previous insolvency such as a Trust Deed or Sequestration, you’ll be more likely to be offered consolidation loans with higher interest rates. In this case, a consolidation loan may not be the appropriate option for you.
Are there other options available?
A debt consolidation loan may seem like a solution to all of your problems, but it may not be the most appropriate.
The Debt Arrangement Scheme (DAS) is a Scottish government backed scheme, similar to the Debt Management Plan (DMP) commonly offered in England, Wales and Northern Ireland, which lets you pay all of your debts at an affordable rate. You’ll set up a Debt Payment Programme (DPP) and receive protection from creditors wishing to take further action against you.
If your debts are more significant, you might want to consider a Protected Trust Deed (similar to an IVA), where any outstanding debt is written off after 4 years. If none of the above options are suitable and you need a fresh start, either sequestration or Minimal Asset Process (MAP) bankruptcy may be the most suitable course of action.
If you are struggling with mounting debt, get in touch with Scottish Debt Expert now for debt help and advice. We can assess your financial situation and provide free debt advice in an initial consultation.