What is a debt consolidation loan?

What is a debt consolidation loan?
Written by Mark Grimley
Published on 6th July 2017
Updated on 2nd May 2018
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A debt consolidation loan can be a helpful way to take control of your debt and manage your money better. Most consumers use them to simplify their finances and avoid paying lots of different amounts to different lenders, which can often work out as an expensive method. Depending on the APR of your loan it could also save you money in the long run with a lower interest rate and a faster way to pay off the debt. So what is a debt consolidation loan? If you are curious about debt consolidation loans and how they might be able to help you, Choose Wisely has the answers.

How does a debt consolidation loan work?

A debt consolidation loan takes all or some of your loans, credit agreements and debts and pays off all those individual lenders so that you only have one sum owing to one lender. You would have to calculate the amount of debt you have outstanding, take out a debt consolidation loan for that amount and pay off your debts in full. You can close those accounts and end the credit agreements which also means that your creditors will stop contacting you as well. You then make monthly repayments for your new debt consolidation loan to the lender that you have applied with. As far as the new lender of your loan is concerned, it is just one payment to them that you are making each month, regardless of how payments there were originally.

How can a debt consolidation loan help?

Juggling different lenders, payment schedules and monthly amounts can be exhausting and stressful. The more outgoings you have, the more likely something will get missed and then things can quickly get out of hand, especially considering late or missed payment charges on multiple debts. A lot of people find a debt consolidation loan simplifies their budget and helps them manage their money better. You can see all your monthly debt repayments in one sum, however, the payments may be spread over longer than the original terms were. Debt consolidations loans can also save you money in the long run if the rate of interest charged is less than the total for the other debts.

How much money can I save with a debt consolidation loan?

The exact amount will depend on the interest rate charged by your debt consolidation lender. If the APR on your new loan is less than on most of the others, or the average of them all, then you should save money in the long run. On the other hand, if the new interest rate is more than most of the others you could end up paying more, especially if it is also over a longer term. It will also depend on the kind of debt you are dealing with. With an outstanding credit card balance, for example, it would probably be cheaper to transfer the balance to a new card offering 0% on balance transfers and try to pay it off in that time, before the period ends. You should also be aware of early payment charges on any of the debts you are consolidating. This is where the lender charges a fee for ending the agreement early, even though it has been repaid in full. You can take this into account for your new loan but it might make a difference in how much you save. You can also save time when handling your budget. If you find yourself with extra money to put into repaying your debt, it is simple to pay off part of main balance without having to choose or negotiate with several different lenders.

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How big is a debt consolidation loan?

You can tailor your loan to the size of your debt. The loans can go very high, to take into account the full amount some people owe which can sometimes reach tens of thousands of pounds. On the other hand, they don’t tend to deal with small amounts and most lenders start debt consolidation loans at £5000 or similar.

What debts can I pay off with a debt consolidation loan?

Any smaller debts, loans, payment plans or credit cards can be settled with a debt consolidation loan. You work out the different debts you want to pay, plus any charges they might have, then apply for that amount from the debt consolidation lender. Once approved you use the loan to pay any debts you choose, or the new lender can pay the loan directly to your creditors so you don’t have to.

Do I need a specialist debt consolidation loan?

Not necessarily. You could take out a personal loan and apply a DIY approach by contacting your lenders directly and paying off each outstanding balance, and any fees that apply. You would want to make sure the loan was unsecured, as you don’t want to put your property at risk if you’re going to struggle with the monthly repayments. As with any other loan the lender will look at your credit score, income, the amount you want to borrow and for how long as well as other acceptance criteria to calculate your risk and creditworthiness. If your debt is mostly or entirely on credit cards you could start by considering a balance transfer to a card offering 0% interest - this will be cheaper than a loan, however you will need to make sure that your new credit limit can cover the total of your debts.

Mark Grimley
Written by
Mark Grimley
Head of Partnerships & Take Control Author at Choose Wisely

Mark joined Choose Wisely in 2015. He continues to work in close contact with the providers, brokers and journalists operating in the world of consumer credit.