What are the pros and cons of taking outa debt consolidation loan? If you’re uncomfortable with the amount you’re recurrently spending every month on a credit card, loan, and other financial product repayments and you want to make them lower, are they really a viable option for you?
But what exactly is a debt consolidation loan?
A person takes out a debt consolidation loan to pay off most or all of their existing credit facilities. Done right, it reduces the amount of interest you pay overall and it can really bring down your monthly repayments. But how do they work?
Why do people take out debt consolidation loans?
According to BBC News, at the start of 2017, the average UK household debt was £13,000. Unsecured debt, as a proportion of household income, stood at 27.4% – a record in British financial history.
Let’s say that a family is £13,000 in debt –some of it on credit cards, and the remainder of it on a loan. The family is paying off their loan as according to their repayment plan and, for their credit card debts, our family is paying those down at 5% per month (or £5, whichever is greater).
With things as they are, how much would they be paying out every month to service that debt and how long would the family be paying off their debts for?
|Credit type||Balance||APR||Monthly cost at start||How long before all paid off?||How much interest will it cost?||Total in repayments|
|Loan (5 yrs)||£5,000||19.9%||£127.75||5 years||£2,665||£7,665|
|Credit Card 1||£2,500||59.9%||£225||7 years 7 months||£1,970||£4,470|
|Credit Card 2||£2,000||29.9%||£145||7 years||£886||£2,886|
|Credit Card 3||£3,500||24.9%||£241||7 years 10 months||£1,295||£4,795|
If a family’s financial arrangements are structured like this, it will take up to 7 years and 10 months to pay off all their current credit facilities at a total cost in interest of £6,816. On a monthly basis, they will make £738.75 in monthly repayments at the start although this figure will reduce over time as the amount of overall debt falls and some of the facilities are paid off.
So, our family is paying up to £738.75 a month to service credit facilities to the value of £13,000. Is there a better way? Potentially.
If the family decided to take out a debt consolidation loan at 19.9% APR for £13,000 over 5 years, they’d be paying £332.15 per month for 5 years, saving up to over £400 a month. They’d end up paying £6,929 in interest rather than £6,816 – that’s slightly more than now but, as we’ve seen, the amount they have to pay off every month is substantially less.
If the family was comfortable with paying up to £783.75 a month, they could take out a loan at 19.9% APR for £13,000. They’d pay £651 each month to service the loan (nearly £90 less than their current arrangement) and pay £2,619 in interest over the 2 years (nearly £4,200 less).
Debt consolidation loans and your credit score
Every time you apply for a debt consolidation loan, the company you’re applying to will carry out a search on you to see your credit report.
A credit report is a detailed record of how well you manage your finances. The report contains constantly updated information on youincluding:
- the number of credit accounts you have (including bank accounts, credit cards, loans, and so on),
- how much of the credit available you’re using (like how close you are to your credit card limits),
- the number of times you’ve applied for credit facilities (like loans, credit cards)
- how many payments you make on time and in full (to loan companies, gas & electric companies, broadband suppliers) and more.
How to get the cheapest debt consolidation loan
Debt consolidation loans are another name used for personal loans. You can either get a debt consolidation loan by approaching a lender directly for one or by using a broker.
Approaching a lender direct for a debt consolidation loan
It always pays to shop around and the same is true with debt consolidation loans. It’s perfectly sensible to want to look at a range of offers available to you so that you can choose the option that works best for you and your situation.
You can easily apply directly to a debt consolidation loan provider using their internet site or by calling to speak to one of their advisors. Each time you apply, you’ll go through a long list of questions about your financial situation, where you work, how much spare cash you have every month, and so on.
It’s after you’ve given across this information that you’ll get an “in principle” “yes” or “no” from a lender. If it’s an “in-principle yes”, that means that they may be happy to lend you money but they’ll need to perform a credit search on you before they come to a firm and final decision. Some lenders may also want you to email or fax over documentation like payslips, passports, and so on.
If you want to get five or ten different quotes from lenders, it’s possible but it will take you a little bit of time to get all the answers you need to make a fair comparison.
Apply for a debt consolidation loan through a broker
On the other hand, you might want to approach debt consolidation loan companies by using a broker instead.
Brokers don’t actually lend you money. What they do is introduce borrowers like you to the lenders most likely to be happy to advance you a loan. The way they do this is because lenders tell brokers (like LoanBroker) the types of borrowers who they’re happiest to work with. Brokers get a long list of requirements from their lenders and when an applicant fills in their details, brokers then match a potential borrower by the details they give over when they’re making their application to the most suitable lenders.
Plus, instead of each of the lenders doing a credit search on you, the broker does it and then they forward your search to each of the potential lenders so that they can get a “yes” or a “no” answer.
That’s important because, if you make too many applications for credit within a short space of time, a lot of lenders don’t like this and they’ll automatically say “no” to your application even if you get an “in principle yes”. Why? It’s because they believe that you’re making so many requests for loans that you must be in financial trouble and desperate for money. That may be unfair but that’s how many lenders view it.
Normally, the entire process takes place within just a few seconds, saving borrowers a lot of time and effort.
In addition, many brokers (like LoanBroker) do not charge applicants a fee for using their service – instead, they get a “thank you” payment from a lender once a loan has been approved and the borrower has signed their online paperwork. Whatever offers a broker comes back to you with, you are also under no obligation to take a debt consolidation loan out and, if you decide not to, there’s no charge for that either.
Alternatives to a debt consolidation loan
If you’re uncomfortable with the level of debt you’re currently in, you may not wish to take out another loan.
If you feel that you’re currently in too much debt and that you need help to sort the situation out, there are a number of different actions you can take:
- Set up a Debt Management Plan – a debt management plan is a plan that you and your creditors agree on as a way for you to pay back all of your debts. Many people use debt management plans if they’re having a difficult few months money-wise and they feel that they need time to recoverfinancially before they can start making repayments again. Others use a debt management plan to reduce their ongoing monthly repayments to something more affordable.
You can set up a debt management plan yourself with your creditors, you can use a licenced debt management company to do so on your behalf (there is a normally a fee payable for their service), or you can ask a charity for help to do so (try approaching StepChange, Payplan and National Debtline).
- Set up a Debt Relief Order – debt relief orders stop your creditors from taking you to court to recover the money you owe them for 12 months after which your debt is canceled in full. You can apply for a debt relief order if you live in England, Wales, or Northern Ireland. There are strict rules in place on who can apply for a debt relief order and you can find out what they are at StepChange’s website.
- Apply for an Individual Voluntary Arrangement – people use individual voluntary arrangements to come to a plan with their creditors to pay off all or part of their debts. You make these payments via an insolvency practitioner who then sends your money to your individual creditors. Find out more about individual voluntary arrangements by clicking here for the Government’s website.
- Bankruptcy is a last resort and most insolvency practitioners and debt charities will probably suggest against you taking this step. Click here to find out more about bankruptcy at the Government’s website.
Do I need to offer security for a debt consolidation loan?
There are many lenders offering debt consolidation loans and those loans will be either “secured” or “unsecured”.
A “secured” loan is a type of loan where you pledge to let your lender have something of yours (called “security”) if you can’t pay your loan back. The best-known example of a type of secured loan is a mortgage but there are other types of security you can offer (depending on the company lending you the money) including your car (for a logbook loan) or valuables (like jewelry or electronic equipment you might offer a pawnbroker).
With a secured loan, your lender will take ownership of your security when you’ve defaulted and they then try to sell it off for the highest value to cover the amount of money that’s still owed on the loan. If they sell it for less than the amount of money you owe, they may still approach you to pay off the remainder.
With an unsecured loan, you don’t need to offer lenders any security for a loan if you meet their lending criteria. However, because the lender doesn’t have any security, that means that your debt consolidation loan will, more often than not, have a slightly higher rate of interest than a secured loan.
What to do once you’ve got your debt consolidation loan
As soon as the loan is paid into your bank account, pay off all your other debts straight away. Now your monthly repayments will be much lower than before so it’s the right time to get the rest of your financial affairs in order.
Be sure to follow these important steps once you’ve received your debt consolidation loan:
- Keep your credit cards locked away but don’t cancel them unless you find yourself unable to resist spending on them. Having open credit card accounts which you don’t use actually improves your credit score rather than having none at all.
- If you need to use a credit card to make an emergency payment, make sure you choose the one which has the lowest interest rate. Don’t pay more in interest than you need to.
- Keep one or two small items of regular expenditure coming out of a credit card account and pay it off in full every month. Over time, this helps improve your overall credit rating.
- Make sure you make all repayments on your debt consolidation loan in time and on full. Missing one or more repayments will have a very negative effect on your credit score.
When you’re arranging your loan, it’s important that the amount you pay back to your lender every month is manageable and that it won’t put pressure on your finances further on down the line. You can reduce the amount of money you pay out every month by extending the length of your loan although this does mean you’ll end up paying more interest.
Get the cheapest debt consolidation loan from licensed lenders with LoanBroker
We’rea team of highly experienced debt consolidation loan credit brokers, not lenders. So, what does this mean for you? We know our lenders really well so when you submit your details to us on your application for a debt consolidation loan, we use that knowledge to introduce you to your ideal finance company.
We enjoy really good and open relationships with all of the companies on our lending panel and, as soon as we get your details, we’ll know exactly which ones will be the happiest to advance you a debt consolidation loan. With us, you can avoid wasting your time by filling out multiple debt consolidation loan applications and that reduces the risk to you of getting a “no” answer to your application.
Start your debt consolidation loan application with LoanBroker today.