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Personal debt in the UK has risen by £63.7bn since September 2020, with the average household owing nearly £63,000 according to The Money Charity. While most people think they can balance their finances, many feel overwhelmed, Citizens Advice currently deals with nearly 2,000 debt issues every day. So it’s no surprise that many are looking for a way to get their finances under control. This is where a debt consolidation loan could be the answer.
A debt consolidation loan is where you take out a larger loan to pay off all your other debts, leaving you with just one more manageable repayment each month. It is often used to simplify finances and get borrowers back on track if they are struggling to get their debts under control. Here are four ways they can help you.
1. Accelerate your way to debt relief
It can be easy to get into the habit of only paying the minimum monthly repayment on credit cards, usually just five percent of the outstanding balance. This means that it will usually take decades to settle the balance, while being charged a considerable amount of interest along the way. You’ll also always have access to your remaining credit limit, putting you at risk of continuing to spend on the card and never reducing what you owe.
Likewise, many people sink so deeply into their overdraft that sometimes, even after they’ve been paid, they don’t make it out. In this situation, it can be hard to justify asking your bank to lower your overdraft limit if it leaves you struggling for the rest of the month. Plus, if you accidentally go over your overdraft limit, most banks charge a penalty and a higher interest rate, making it a costly situation.
Consolidating your debts into one loan means you’ll have a fixed end date in sight, so you’ll know exactly when you’ll be debt-free. Provided you can follow the repayment schedule, knowing when your debts will be paid off can be a huge financial stress reliever.
The interest rate charged is usually much lower than that of a credit card, and spreading out repayments over time can mean that these payments are lower and more manageable. However, there are usually fees attached to these types of loans and different providers charge different rates, so it pays to shop around.
To get an idea of how much you might need to borrow and for how long, the experts at Loan.co.uk have a very useful debt consolidation calculator.
2. Process only one refund
If you manage several lines of credit, you will have to manage several amounts and repayment periods. While this is often made easier by setting up a direct debit for the amount you need to pay, you still need to make sure you have enough funds in your bank account to cover each transaction.
This is where many run into problems: either they don’t have enough money to cover all the direct debits they have put in place, or they have so many repayments to make at different times that it it’s easy to forget what you owe where. The problem with missed or late payments is that they usually incur fees, on top of the interest you usually pay, which further increases the debt. Add to that the damage it does to your credit score, and it’s not hard to see why multiple repayments can quickly become a serious problem.
A debt consolidation loan comes with a single payment, for a fixed amount, at the same time each month until it is paid off. It’s common for people to set up a direct debit to have this payment automatically taken from their bank account shortly after payday. This means they can be sure they can repay the right amount, at the right time, month after month.
Another advantage of having only one reimbursement is to make everyday life more manageable. Without having to track so much, it should be a lot easier to see how much disposable income you have each month, and a lot less stressful on you and your finances in general.
3. Potentially get lower interest rates
Most debt consolidation loans will fall under the category of ‘homeowner’ or ‘secured’ loans, which means that your home will be used as collateral against the amount you are borrowing. With this security, there is less risk for the lender, who will therefore be more likely to offer you better interest rates.
This can be especially helpful if your debt is spread across multiple lines of credit. In particular, payday loans, overdrafts and some credit cards carry some of the highest interest rates on the market. If you only have enough money to pay off the bare minimum on these types of credit, and the interest rates are high, it could take you decades to be able to fully pay them off.
By getting a debt consolidation loan with a lower interest rate, you will find that more of the repayment amount will go towards debt reduction rather than interest.
Keep in mind that you usually take out a debt consolidation loan for a longer period than an unsecured loan. Although interest rates may be lower, you could pay more interest overall. However, it is often worth it if it makes everyday life much easier.
4. Improve your credit score over time
If you’re struggling to manage your debt and you’re prone to making late payments, or worse, missing payments altogether, it could really hurt your credit score. Any missed or late payments will be recorded on your credit report for six years, which means that even if you’ve settled your debt for a long time, you could still suffer the effects for years.
Also, if you repeatedly fail to keep up with your repayments, you may find that your lenders are taking other steps to get their money back. This could include legal action, which could lead you to a CCJ (County Court Judgment) or an IVA (Individual Voluntary Arrangement).
These will also remain on your credit report for six years, but it can be nearly impossible to get approved for other lines of credit. While it’s best not to borrow more money while you’re paying off debt, it could also affect much more mundane things like renting a property and getting a cell phone contract.
Paying off your creditors and closing your accounts with them using a debt consolidation loan is a great first step towards improving your credit score. Then, provided you can keep track of your repayments on your debt consolidation loan, you will demonstrate to lenders that you are a responsible borrower who can handle credit well, which can go a long way to improving your credit score.