The more debts you have, the more challenging they can be to manage. You may have different types of debt that need to be repaid on different days of the month to different lenders charging different rates. Not only will this put a strain on your time, but it also increases the chances of you missing a repayment.
Consolidating your debt can simplify the repayment process and – in some cases – make repaying what you owe more affordable. One option when it comes to consolidating your debt is a personal loan. Loans generally allow you to borrow more money than you could with a credit card or overdraft and at a lower rate, though you will not benefit from the 0% interest deals offered on many credit cards. In this article, we will explain how debt consolidation loans work, who they can benefit and what other options you could consider.
What is a personal loan for debt consolidation?
A debt consolidation loan is an amount of money you borrow to pay off multiple different debts, leaving you with one monthly repayment instead of many. For example, you could take out a new loan for £9,000 in order to pay off three different £3,000 loans. You use the money from your new loan to pay off existing debt, then repay the debt consolidation loan. This can reduce the cost of your debt – if your new loan charges a lower rate of interest than your existing debt – and should simplify the process of paying the money back.
Juggling more than one monthly repayment can be challenging and could lead to accidental missed payments, so consolidating your debt could ease some of the strain of paying back what you owe. This can be especially helpful if the debts you are consolidating are from different forms of borrowing, charging different rates and repayments are due on different days. For example, you could be repaying a credit card, overdraft and personal loan. Your debt consolidation loan could be repaid over a longer period than your existing debt, making the monthly repayments more affordable. Keep in mind that adding to your loan period could make the debt more expensive overall, as the sooner you pay the money back, the less time there is for interest charges to compound and build up.
Debt consolidation loans can be either secured or unsecured. Secured loans require you to put up a valuable asset – such as your home – as collateral that can be sold if you do not repay the loan. Unsecured loans do not require collateral, as how much you can borrow will depend on your credit score and financial circumstances. We explain the difference in detail on our article 'Secured vs unsecured loans: Making the right choice'.
How does a personal loan for debt consolidation work?
Applying for a debt consolidation loan follows a similar process to taking out any other kind of loan. Once you have the money, you need to pay off your existing debts, then focus on repaying the debt consolidation loan. Here is the step-by-step process to follow:
- Work out what you owe - You will need to calculate the total cost of your existing debts – across credit cards, loans and overdrafts – in order to know how much you need to borrow for your debt consolidation loan.
- Apply for a debt consolidation loan - Most loans allow you to apply online, while some applications can be made over the phone or in person. The lender will run a credit check and affordability test to measure how likely you are to repay what you are borrowing. This means that some people may not be able to borrow the full amount they applied for or at the lender’s lowest rate. We have the best loan deals in our article 'The best personal loans'.
- Pay off your debt - Once the money from your debt consolidation loan has been paid to you, you can pay off your existing debts. If you cannot borrow enough money to clear everything you owe, you should prioritise the lenders that charge the highest rate of interest.
- Pay off the debt consolidation loan - Now that you only have one repayment to make, it should be much easier to manage your debt and make sure all of your instalments are paid on time. You will know how many months it will take to clear and exactly what you owe to become debt free, which should make planning for the future much easier.
What can a personal loan for debt consolidation be used for?
You can use a debt consolidation loan to consolidate almost any type of debt you have, though you should always make sure that it results in you paying less overall. If you are repaying multiple debts at low rates, for example, on more than one 0% purchases credit card, consolidating your debt with a loan may not be the best option.
Most people will be able to use a debt consolidation loan to pay off:
- Other personal loan debt - You may have taken out unsecured personal loans to pay for a car, a holiday or to fund home improvements. These debts can be consolidated using a debt consolidation loan.
- Credit card debt - If your credit card is charging interest on your balance, it is likely to be at a higher rate than what you could get through a personal loan. Consolidating your debt with a loan could mean you pay less overall.
- Overdrafts - An overdraft can be one of the most expensive ways to borrow money, as banks often charge very high rates of interest. Using a debt consolidation loan to clear your overdraft or overdrafts could be much cheaper than paying off the debt steadily.
What are the pros and cons of a personal loan for debt consolidation
Here are the main advantages and disadvantages of taking out a debt consolidation loan:
Pros of a debt consolidation loan
- Pay less each month - You could consolidate your existing debt into a long-term loan, which could reduce how much you pay each month. This would make meeting your repayment schedule more affordable, though the longer you take to repay a debt, the more expensive it will be.
- Pay less overall - If your debt consolidation loan comes with a lower interest rate than you are paying on your existing debt, you will pay less overall if the term remains the same.
- Simple repayments - Managing multiple repayments every month on different days across multiple types of debt can be a headache. One repayment is much easier to keep track of.
- Help your credit score - The more repayments you have to make each month, the more likely you are to forget to make one. By minimising your debts you are less likely to miss payments that will damage your credit score and make future borrowing more difficult.
- Borrow more - The upper borrowing limit on a loan is likely to be higher than a credit card, so it can be a more effective consolidation tool for people with considerable debt.
Cons of a debt consolidation loan
- New debt - Getting a debt consolidation loan means taking on additional debt, which can bring problems, especially if it involves increasing how long it takes you to pay off what you owe. If you feel out of control of your finances and are worried about your debt, read our article ‘Where to get free debt advice’.
- Not everyone can get a loan - Taking out a debt consolidation loan when you are already in debt may not be possible for a lot of people, especially if you do not have a strong credit score.
- Other options may be better - A loan is not the only way to consolidate debt, and it may not be the cheapest. Some debts can be consolidated using a credit card, which could allow you to benefit from a 0% interest offer. Read our article 'What is the best way to consolidate my debt?' for more information.
- Fees - Some loans will come with set-up fees, late payment charges and early repayment charges. These extra costs could potentially outweigh the savings from consolidating your debt.
How much does a personal loan for debt consolidation cost?
Your debt consolidation loan should ideally cost less than your current debt, otherwise, you will not be making a significant difference to your final situation. The cost savings could be through lower monthly payments or in the overall cost of the loan. Here are the key factors to look out for to understand how much your debt consolidation loan could cost:
- Loan amount - In most cases, you will pay more in interest if you borrow more money. You will need to borrow enough money to pay off your existing debts.
- Loan term - A longer loan term will mean you spend longer clearing your debt and give more time for what you owe to grow with interest. However, some providers may offer you a lower interest rate if you opt for a longer term. You will need to select a term that spreads your debt over enough time to make the monthly repayments affordable.
- APR (annual percentage rate) - This is the total cost of your loan in the first year, including standard fees. It is a good idea to look for a rate that is lower than what you are currently paying on your debt in order to maximise the benefits of a debt consolidation loan. If you have a low credit score, you may be offered a lower rate than the one advertised by your chosen lender.
- Fees - Some loan providers will charge set-up fees, early repayment charges and late repayment charges. Make sure to take these into account when you compare your borrowing options.
Debt consolidation loan alternatives
A debt consolidation loan will not be the right option for everyone. Some people may be anxious about taking on extra debt, some will be unable to take one out because of their credit history and others may find that it is not the cheapest way to consolidate their debt. Here are some alternative options you could consider:
- Balance transfer credit card - If you want to consolidate your credit card debt, the cheapest option is usually a balance transfer credit card. These cards often come with long 0% interest periods that allow you to spread repaying the balance or balances you move over, across many months. Most cards charge a fee to transfer a balance, though there are also free options. You can read more in our article 'What is a balance transfer credit card and how does it work?'.
- Money transfer credit card - A money transfer credit card allows you to build up a balance by transferring money to your current account. You can then use this cash to pay off loans or overdrafts. There is usually a money transfer fee, though some cards will come with an initial 0% interest period. We explain more in our article ‘How to consolidate debt with a credit card’.
- Remortgage - In some cases, remortgaging to release equity from your home will be the cheapest way to access extra cash. This comes with more risk than a personal loan, as your home could be sold if you fail to make repayments, but you may be able to access more money at a lower rate.
- Debt management plans - This is an alternative to consolidating debt and involves negotiating the terms of your loan with your lender. You may be able to agree on new monthly repayments that are more affordable.
- Free debt advice - Rather than approach your lender or lenders directly, you could seek out free debt advice first. There are a number of different organisations that offer independent advice on debt management for free.