What does debt consolidation mean?
If you have multiple types of debt - whether that’s credit cards, overdrafts or loans - combining them into one monthly payment can make managing your finances much easier and also save you money. Combining your debt in this way is known as debt consolidation. If you are not sure how to consolidate debt, there are a number of different ways to go about it, as we explain below.
6 ways to consolidate debt
We’ve outlined six different methods for consolidating debt, along with their pros and cons.
Consolidating debt by credit card balance-transfer
A balance-transfer credit card can be a convenient and relatively simple option for credit card consolidation. A 0% balance-transfer credit card allows you to move existing card balances across and avoid paying interest for a set number of months. If you are paying high rates of interest on your existing balances, a 0% balance-transfer card can save you a tidy sum of money.
However, you will usually need to pay a transfer fee which will be added to your new balance, and the best deals are reserved for those with good credit scores only. Also note that if you don’t clear your balance before the 0% period ends, you will start paying interest. More information on 0% balance-transfer cards can be found in our article "Best 0% balance-transfer credit card deals".
Another option is to use a balance-transfer card that offers a low rate of interest for the life of the debt, so there’s no deadline by which you need to have cleared it. Although you will still pay interest, it could be more competitive than the rate you are paying on your existing card balances. Some low APR credit cards have the added benefit of no balance-transfer fee.
Be aware, however, the limit on a credit card may not be high enough for your needs and it may take you a long time to pay off your debt, particularly if you only make the minimum repayment each month.
Consolidating debt using a personal loan
Personal loans typically let you borrow more than with a credit card and interest rates can be competitive, particularly on sums of £7,500 or more. You could therefore consider applying for a personal loan and using your loan to pay off your existing debts.
The downside, however, is that the most competitive rates will typically only be offered to those with excellent credit scores. Monthly payments are fixed which makes it easier to budget, but this also means you must be sure you can afford to make your payments each month. Failing to pay on time or missing payments completely can negatively affect your credit rating.
For more information, visit our article "Is it better to get a credit card or a personal loan?".
Consolidating debt using a debt consolidation loan
A debt consolidation loan is specifically designed to help bring all of your debts together in one place. You then make fixed monthly payments to your loan provider. This can work out to be cheaper and much more manageable.
There are two types of debt consolidation loan - secured and unsecured. A secured debt consolidation loan means the amount borrowed is secured against an asset, often your home. If you can’t keep up with your repayments, you risk losing your home. An unsecured debt consolidation loan, on the other hand, is not secured against an asset and is seen as the less risky option.
But while debt consolidation loans can be useful, the downside is that you may end up making large payments to your provider and the term of your loan could span several years, resulting in you paying more overall. You should also check the small print carefully as some companies charge high fees for arranging the loan, or you may be charged for paying back your loan early.
If you are not sure whether to consider a debt consolidation loan, you should ask yourself if you will still be saving money once any fees have been factored in and if you will pay less interest overall. You should also make sure you can afford the monthly repayments. If you can’t, or taking out a debt consolidation loan is going to work out more expensive in the long run, this type of loan is unlikely to be right for you.
Consolidating debt using a home equity loan
It is also possible to remortgage your home to consolidate debts. When you remortgage, you can release the equity in your home and if the value of your property has increased significantly, you may have a decent sum to put towards your other debts.
This can be a particularly tempting option if mortgage rates are low. But it is important to keep in mind that you will be increasing the size of your mortgage loan and your monthly repayments may rise as a result. If you can’t keep up with these repayments, your lender could ultimately repossess your property.
You should also factor in the cost of any booking, arrangement, valuation and legal fees when you remortgage. Keep in mind too that you will be borrowing over a much longer period of time than you would with a credit card or loan, so it can work out to be more expensive.
Finally, it is worth noting that remortgaging with debt won’t necessarily be easy. Lenders will check your credit rating to see how well you have managed your debt repayments in the past, but they will also examine your bank statements and spending habits. If they believe you are struggling financially this can affect the amount you can borrow against your property or the interest rate you pay. You should therefore think about this option very carefully.
You can find out more about home equity loans in our article "Remortgaging to consolidate debt".
Borrow from retirement
If you have been saving into a pension and are aged 55 or over, rules introduced in April 2015 allow you to withdraw money from your pension pot whenever you need it. So you could potentially make a withdrawal and use the funds to pay off your debts. The first 25% of each withdrawal you make will be tax-free, but you will pay tax on the remaining 75%.
However, before you choose to go down this route, you should keep in mind that as you withdraw money from your pension, your pot size will reduce. When you come to retire, you could find your pension isn’t large enough to support you. It may therefore be a good idea to seek advice if you are considering this option. If you are considering this option, visit our article "10 tips on how to find a good financial adviser".
Borrow from friends or family
An alternative way to help pay off your debts is to ask family or friends for financial help. The main advantage of this is it can be a much cheaper way of paying down your debts. However, it is important to establish a few ground rules first. Make sure you draw up a budget in advance by taking a look at all your outgoings and earnings and work out how much you can realistically afford to pay your friend or family member back each month. It can be worth putting this in writing.
It is also important to be honest with the person lending you the money. If you can’t make your payment one month, you should talk to your friend or family member as soon as possible and come up with a new repayment plan. If you are not honest, you could risk losing your friendship.
Pros and Cons of consolidating debt
Below are some of the pros and cons of debt consolidation:
Pros of consolidating debt
- Payments are combined and can be more manageable
- Depending on the method you use, you can pay off your debts more cheaply
- You may be able to clear your debts more quickly
- Keeping up with your repayments can help your credit score
Cons of consolidating debt
- There may be extra fees involved
- You could end up paying more over the long-term
- Depending on the method you use, you could be putting your home at risk or reducing your retirement income
- If you can’t keep up with repayments, your credit score will be negatively affected
What is the best way to reduce debt?
If you are thinking about consolidating debt, it’s important to consider your options carefully. If you have expensive credit card debt, moving it over to a balance transfer credit card can be a quick and easy way to save money and clear your debt.
A personal loan can also be a cheaper way to help you pay down debt. If you’re planning to apply for a debt consolidation loan, make sure you’ve factored in any fees and worked out whether the monthly payments are affordable. It is also best to choose an unsecured loan rather than secured. Borrowing on your mortgage or using your retirement income are generally considered riskier ways to consolidate debt and these options should be considered with extra care.
Remortgaging to consolidate debts can be expensive and if you are unable to keep up with your mortgage repayments you could ultimately lose your home. If you’re "borrowing" from your pension, remember that this will affect how much income you have to retire on.
If you are struggling with the amount of debt you have, consolidating your debt won’t always be the answer and it’s important to take steps to help pay it off and improve your financial situation.
It is worth going through all your bank statements, credit card statements and other bills with a fine-tooth comb to work out how much you are spending and how much you are earning each month. Chances are you are spending far more than you are earning, so see whether there is anywhere you can make cutbacks or save money.
For example, are you paying for a gym membership or magazine subscription you don’t need? Could you start buying "own brand" products at the supermarket instead of premium brands? Could you switch to a cheaper energy tariff or mobile phone deal? Taking steps such as these can free up cash to put towards your debts, but it’s important to then establish a budget each month so that you don’t keep overspending.
A good way of analysing your spending and understanding budgets is to use a budgeting app, check out our article "The best budgeting apps in the UK: How to budget without even trying".
Where to get help if you are experiencing debt problems
If you are concerned about the amount of debt you have, it is best to seek advice as soon as possible. Don’t bury your head in the sand as your problems will only escalate - there is always help available. A number of charitable organisations and websites offer fee-free advice and can talk through the various options available to you to help you tackle your debt and get on top of your finances. They can also advise on debt consolidation plans.
Some of the places you can turn to include:
- Citizens Advice
- The Money Advice Service
- National Debtline
- The Money Charity
Find out more in our article "The impact of debt on your mental health and how to get help".