Consolidating debt with a personal loan

A debt consolidation loan is essentially a personal loan that is used to combine all your debts into one monthly repayment.

If you find juggling several high interest debts a challenge, a debt consolidation loan could help you to keep on track of your finances. It might also help you to keep an eye on how much you have left to pay in total.

Wondering whether you should consolidate your debt with a personal loan? This guide explains what a debt consolidation loan is in more detail, along with the pros and cons.

Introduction to debt consolidation

Debt consolidation, as the name suggests, helps you to combine your debts into one. You can use a consolidation loan to pay off various forms of debt, including credit cards, loans, your current account overdraft or store cards. Some of these debts may carry high interest rates, which might make borrowing money over a long period costly. As debt mounts up, you could find it challenging to know which debt to prioritise and how to clear your debt as quickly as possible.

Consolidation loans allows you to reorganise your finances so you have just one single loan to think about.

A debt consolidation loan works like this:

• Calculate how much debt you have, including any additional costs such as early repayment fees
• Apply for a personal loan for that amount
• If accepted, use the money from the loan to pay off what you owe
• Pay your loan back over a series of months at a fixed rate

Who might debt consolidation be suitable for?

Debt consolidation may be potentially suitable if you…

• Have an amount of high-interest debt
• Are committed to getting your finances in order
• Have no immediate plans to take out additional credit (aside from the consolidation loan)
• Are comfortable sticking to a structured, fixed-rate repayment plan over an extended period
• Have a good credit history, which may help to secure you a more competitive interest rate
• Feel able to afford the loan repayments in full each month (people used to only paying off the minimum balance may need to consider the impact paying a higher monthly amount might have on their finances)

Taking out a debt consolidation loan is a big financial decision so always consider your options carefully. You may wish to seek free debt advice from an organisation such as StepChange.

Pros of cons of a debt consolidation loan

There will always be advantages and disadvantages to different financial products. Some options may be more suitable for you based on your individual circumstances, so always consider both the pros and cons before applying for any type of credit. As previously mentioned, before committing to taking out a consolidation loan, you may wish to seek free, independent debt advice.

Pros of a debt consolidation loan

• Could make debt more straightforward to manage, as you’ll have just one monthly payment to consider and one finance provider to interact with.
• With just one loan, you may find it easier to envisage a timeline of when you’ll be debt free (if this is a goal you’re working towards).
• You’ll pay the same amount every month because a debt consolidation loan is fixed rate. This means your interest rate remains the same throughout the duration of your loan and so your monthly repayments will be consistent too. This can help you to budget more effectively.
• It’s clearer to see how much interest you need to pay in total when you have just one loan to think about. You’ll know your rate and the total amount payable from the outset of your loan agreement.
• Depending on your lender, you may be able to make extra payments or settle your loan early without incurring penalty fees. This could help you to manage your debt your way.
• Depending on the interest rates of your existing debts, you may be able to reduce the amount of interest you pay monthly (but only if your loan’s Annual Percentage Rate - the APR - is lower than that of your existing debts).
• You may choose to pay back your debt consolidation loan over a longer period of time, which could reduce your monthly payments (though be aware that you could end up paying more interest in total this way).
• A debt consolidation loan is a type of unsecured loan. It doesn’t require you to put up collateral, so you can preserve your assets.

Cons of a debt consolidation loan

• A debt consolidation loan doesn’t address the root cause of your debt. If you have struggled to manage your finances in the past, there is a chance you could fall back into a cycle of accumulating new debts in the future. It may be beneficial to reflect on your spending habits and how you typically manage money, seeking professional advice or support from a debt advice charity if needed, before applying for a loan.
• The interest rate you’ll be given will depend on your personal and financial circumstances, credit history, loan amount and term. If you have a less-than-perfect credit history, you may not be able to secure the most favourable rates. This could make a consolidation loan a less attractive option, particularly if the APR you’re offered is the same or higher than that of your existing debts.
• While consolidating your debts may help reduce the amount you pay each month, you may find that you’ll pay more interest overall when you spread the cost over a longer period of time.
• You may be charged a fee for settling your existing debt early or transferring the debt, which can add to your overall debt burden. Make sure you factor in these costs when considering how much you might potentially save as a result of consolidating your debt.
• While debt consolidation combines debts into one, it doesn’t eliminate debt altogether You will still be responsible for repaying the full amount and your credit score will be affected if you do not make your monthly loan repayments in full. It’s therefore so important you consider the affordability of a debt consolidation loan and how the monthly payments might impact your finances before applying.
• Depending on the level of debt you have, a debt consolidation loan may not be able to provide the relief you need. If your debt situation is more severe you may wish to speak to a debt advice charity to discuss alternative debt relief options.

How might getting a personal loan for debt consolidation impact your credit score?

Applying for and taking out a debt consolidation loan may have an impact on your credit score. However, depending on how you manage your debt, it could ultimately affect your score positively.

In the short term, applying for a loan will cause your credit score to lower. That’s because applying for a loan will result in a hard credit check, which will be recorded on your credit report. Hard credit searches temporarily lower your credit score but, providing you don’t apply for several different loans in quick succession, this is unlikely to have a long-term impact.

The main way a debt consolidation loan could negatively impact your score is if you fail to make your repayments. Late or missed payments will be recorded on your credit file and could make it more expensive to borrow – or even more difficult to obtain credit - in the future. If you think you might not be able to keep up with your repayments, then getting a personal loan to consolidate your debts may not be a suitable option as mismanaging your debt could have a long-term impact on your credit score.

You may also find that closing old accounts, such as old credit card accounts you’ve paid off with the personal loan, could reduce the average age of your accounts. This may have a minor negative effect on your credit score, though this is typically outweighed by the benefits of paying off higher-interest debt.

All that said, if you make your repayments on time each month you could find that consolidating debt with a loan can actually have a positive impact on your credit score. That’s because demonstrating responsible money management shows lenders that you’re more likely to repay what you owe on time in the future too.

Reducing your debt could have a positive overall impact on your credit score too. It can be quicker and perhaps more straightforward to pay off one debt with just one monthly repayment to think about, so a consolidation loan could help you to pay off your debt sooner. As you pay off your existing debts and make on-time payments on the consolidation loan, your debt-to-income and credit utilisation ratio may improve. This could, in turn, improve both your creditworthiness and affordability.

For more information, take a look at our guide on how a personal loan can impact your credit score.

How to get a personal loan for debt consolidation

If you are considering applying for a debt consolidation loan, always thoroughly research lenders to ensure they offer the product that meets your needs, and that you meet their eligibility requirements.

You can use headline APRs to compare the cost of borrowing across multiple different lenders. However, do remember that though 51% of customers will be given the advertised rate, you may receive a different rate to those advertised depending on your personal circumstances.

Once you have decided on a particular lender, you will likely be able to apply for a personal loan online. Find out what you owe across your existing debt (add up the balance, plus interest and any fees), apply to borrow that amount, pay off your existing debt with the loan and start making your monthly repayments.

Continue to follow your budget and make timely repayments on the new debt consolidation loan, avoiding incurring any additional debt if possible. You’ll be able to track your progress as you pay down the loan, helping you to stay motivated on your path to becoming debt free.

Alternative debt consolidation options

There are a few different options to consider when it comes to managing your existing debt. The best approach will depend on your individual financial situation, and your priorities when it comes to paying off your debt.

For example, is it more important to you to become debt-free quicker, to lower your monthly repayments or to pay the least amount of interest over time? The answers to these questions will likely help you to decide the best option for you.

You may also find it beneficial to consult with a financial advisor or contact a debt advice charity to help you decide on a suitable plan of action.

Pay off your existing debt over time

Instead of consolidating your debts, you could investigate alternative ways to manage your existing debts. For example, the ‘snowball’ method involves paying off your debts one by one. You’ll start by paying off the smallest balances first, while making minimum payments on the rest. Over time, you’ll start to see more and more of your debts being paid off.

Another common method is the ‘avalanche’ method, where you’ll prioritise debts with the highest interest rates first. This can help you to save more money in interest over time, though it may take a bit longer to pay off individual debts.

It could be helpful to approach a free debt management charity such as StepChange to discuss your debt. You may find it beneficial to work with a professional to create a plan for paying off debt most effectively.

Balance transfer credit card

A balance transfer credit card may be appropriate for someone with smaller debts. Some companies offer 0% or low-interest introductory rates on bank transfers, so transferring high-interest debt to one of these cards may save you money on interest. This might be suitable if you only have a small amount of debt, and a clear plan for paying it off before the 0% period ends.

It’s also important to be mindful of how you plan to use the card in the future. If you continue spending on the card and don’t pay off the full balance each month, you may end up paying high interest rates which could put strain on your finances.

Remortgaging

If you own a home, it may be possible to remortgage to settle your debts.

Of course, a mortgage uses your home as collateral. This means that your lender is entitled to seize your assets – in this case, your house – if you fail to keep up with your repayments. It’s therefore important to be cautious before remortgaging to pay off other debt.

The next steps for choosing a debt consolidation loan

If you believe a debt consolidation loan could be a good option for you, the next step is to find out how much it could cost (each month and in total) to borrow the money you need to pay off your existing loan.

Our online loan calculator gives you an idea of how much a loan could cost based on our advertised rate. This will help you to work out whether debt consolidation loan repayments may be more affordable and more straightforward to manage than your existing debt.