DebtPersonal Finance

Is It Worth Consolidating Debts Into One?

Man with his head in his hands looking at a handfull of offical letters

Struggling to keep up with your monthly outgoings? Whether it’s credit card bills, finance payments, or even a loan you’re repaying, having multiple debts can very quickly become overwhelming and unmanageable. Consolidation may seem like the perfect solution to keeping track of your outgoings but, like any financial solution, whether it’s right for you depends on a number of factors and your own personal circumstances.

What is debt consolidation?

Put simply, debt consolidation is combining all of your debts into one manageable payment. This is done by taking out a single loan, generally at a low interest rate, to pay off all your debts. Then you just repay the single loan rather than keeping track of multiple outgoings. It’s a good way to keep your finances organised and makes budgeting much easier.

How does debt consolidation work?

Say you have three loans and a credit card bill which, combined, puts you £20,000 in debt. Add to this the fact that each debt has a different repayment date throughout the month. Rather than getting confused over how much money is leaving your account and when, you can take out a loan for £20,000 to pay off your three loans and clear your credit card bill. Then, you’ll only need to worry about the single monthly repayment on the new loan.

Often, debt consolidation can also lower your monthly repayments, which can make day-to-day living more manageable.

There are two types of loan you can choose between when it comes to debt consolidation:

Secured loan

Secured loans allow you to borrow money by using an asset you own (usually your home) as collateral. The collateral is essentially security for the lender — if you can’t keep up with repayments, the lender can sell the asset as a way of getting their money back. However, because of the added security for the lender, you can usually borrow a higher amount of money than with an unsecured loan.

Perhaps the most common example of a secured loan is a second charge mortgage which, as explained by Loan.co.uk, is where you secure your loan against the equity you hold in your home. Equity is how much of your home you own outright — that is, the percentage of your home that you’ve already paid off with your mortgage. For example, if you own 20% of your home worth £300,000, you could take out a loan worth up to £60,000 with a second charge mortgage. 

It’s important to note that a second charge mortgage does not replace your existing mortgage, and you will still need to make payments on your original mortgage as well as the second charge loan.

Unsecured loan

An unsecured loan, like a personal loan, isn’t secured against an asset. Instead, the lender will require you to meet certain criteria to give them confidence you’ll be able to repay the loan. This type of loan is generally reserved for those with excellent credit scores, although personal circumstances such as your annual income will also be taken into account.

What are the benefits and drawbacks of debt consolidation?

Consolidating your debts comes with a number of pros and cons, and it’s important to understand them so you can make an informed decision before proceeding.

Benefits of debt consolidation

Streamline finances

Rather than keeping track of various payments and interest rates, you only need to think about a single repayment. This reduces your chances of ever making a late payment or missing one entirely, which in turn will help in protecting your credit score. You’ll also gain a better idea of when you’ll be debt-free, instead of having to sift through multiple repayment plans.

Reduce monthly repayments

In some cases, consolidating your debts can actually decrease your monthly outgoings. If you have several outstanding debts, you will be paying interest rates on each debt individually. With all debts consolidated into a single loan, you’ll only be paying interest on one debt. Furthermore, you may be able to negotiate a longer loan term with more affordable monthly repayments.

Improve credit score

Debt consolidation can reduce your credit utilisation rate, which is the amount of money you owe divided by the credit limit. For example, if you have £10,000 in credit but have a balance of £5,000, your credit utilisation rate is 50%. Having a low utilisation rate essentially means that you’re using less of the credit that’s available to you. A credit utilisation rate is considered one of the more influential factors of your credit score, so it’s important to keep this as low as possible.

Drawbacks of debt consolidation

Added costs

Clearing any line of credit early may bring about extra closing costs or early repayment fees. A debt consolidation loan can also leave you with a lengthy repayment plan. Your consolidation loan may well extend over the course of several years and, if the interest rates are high, this could mean you’re paying much more than you would without consolidation, even if your monthly repayments are lower.

Doesn’t resolve financial issues altogether

Consolidating debts makes it much easier to handle your monthly repayments, but it doesn’t remove the amount of money you owe altogether. You’ll still need to identify the financial habits that got you into trouble in the first place and lay the groundwork for better financial behaviour.

Ultimately, whether debt consolidation is right for you depends on your unique circumstances. If you have a good credit score, you’ll have a better chance of securing a lower interest rate than you have on your current debt, saving you money in the long run. But, a debt consolidation loan will only be beneficial if you can actually afford to repay it. Failing to do so could lead you into a deeper financial hole. Debt consolidation can provide financial relief by helping you to streamline repayments, but it’s not a solution to every financial problem  – youl’l still need to resolve the habits or reasons that led you into debt in the first place.

About author

Poppy loves personal finance almost as much as she loves her two cats, Tif and Taz.
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