Finding the best debt consolidation loan for you

Debt consolidation loans can be a helpful way for people to manage their existing debts. Find out all you need to know about debt consolidation with our guide.

What is a debt consolidation loan?

Having multiple debts can be difficult to manage and costly. A debt consolidation loan can help you to manage your existing debts by consolidating them into one single lower monthly payment.

You’ll need to apply for a loan large enough to pay off the balance of your existing debts, whether that’s credit cards, loans or overdrafts.

There are two types of debt consolidation loans:

Secured debt consolidation loan – This is a type of secured loan where the lender guarantees the money you borrow against your home. These are also often referred to as homeowner loans and are typically offered when you owe a significant amount of money or have a poor credit history.

Unsecured debt consolidation loans – Also referred to as personal loans, this is a type of loan to pay off debt, that isn’t secured against your home or other assets.

How do debt consolidation loans work?

Debt consolidation loans are a way to pay off your outstanding debts and consolidate them into one manageable payment. When you owe money to multiple lenders, you’ll not only be paying back what you’ve borrowed but also different interest charges.

Combining your current debts with a consolidation loan can reduce your monthly repayments and save you money on interest.

Here’s how debt consolidation loans work:

  1. Work out how much you owe – Include all your debts from lenders like loans, credit cards, overdrafts and store cards. The total will be the amount you’ll need to borrow from a debt consolidation lender.
  2. Use the consolidation loan to pay off debts – Once your application is approved, you can use the money to pay off your existing debts.
  3. Stay on top of your payments – Once you’ve paid off all your existing debts, you’ll need to keep on top of your monthly payments and pay back the debt consolidation loan within the specified term.

Does a debt consolidation loan affect your credit score?

When you apply for any form of credit, a hard search will be recorded on your credit report. Whilst this may temporarily harm your credit report, staying on top of monthly payments and not making multiple credit applications should prevent long-term damage to your credit history.

Consolidation loans could reduce your chances of missing payments by offering a more manageable way to pay back your existing debts.

Something to bear in mind when considering a debt consolidation loan is that until you’ve used the loan to pay off your current debts, you’re effectively doubling your credit utilisation which could impact your affordability. However, as long as you use the money borrowed to clear your outstanding debts, any adverse effects on your credit report should be temporary.

How much does a debt consolidation loan cost?

Debt consolidation loans are tailored to your personal circumstances. The overall cost of a consolidation loan can vary depending on several factors, including:

  • How much you need to borrow – The amount you need to borrow will depend on how much existing debt you have.
  • Loan term – How long you need to pay off the loan; this will depend on how much you borrow and how much you can afford to pay each month.
  • Annual percentage rate (APR) and additional fees – How much interest you’ll pay on top of the amount borrowed; this can vary between lenders and will be impacted by your credit history. Lenders may also charge additional fees such as an annual fee, arrangement fee or early repayment charge.
  • What can I use a debt consolidation loan for?

You can use a debt consolidation loan to pay back almost all types of debt, such as:

  • Credit Cards
  • Personal Loans
  • Overdrafts
  • Store Cards/ Payment Plans

Some types of debt such as mortgages cannot be repaid using debt consolidation loans.

Can I get a debt consolidation loan with bad credit?

Getting a debt consolidation loan for poor credit is possible. However, it’s likely the best deals and lowest interest rates may not be offered to you if you have a low credit score.

If you have a bad credit history, some specialist providers may be able to offer you an unsecured debt consolidation loan for bad credit.

You’re more likely to get a better deal by taking a secured debt consolidation loan if you own some or all of your home, or another high-value asset such as a car.

Secured debt consolidation loans don’t come without risk – it’s important to remember that missing repayments on a secured loan will put your home (or the asset you’ve used to secure the loan) at risk.

Guarantor loans are also an option for bad credit debt consolidation. These are a type of personal loan which are guaranteed by a close friend or relative, who agrees to pay off your debt if you’re unable to.

Are there any alternatives to debt consolidation loans?

Whilst a debt consolidation loan can be an effective way to manage your debts, some alternatives may be more suitable for you.

0% Balance Transfer Credit Card

0% balance transfer credit cards allow you to transfer your current credit card debt to a new card, where you won’t have to pay interest for a set period – typically between six to eighteen months. Most balance transfer cards will charge a small balance transfer fee, usually between 0-3%.

Balance transfer cards can be a great alternative to loans, to pay off credit cards, without accumulating interest. It is, however, essential to consider if you can completely pay off the balance before the interest-free period expires, because at this point, many balance transfer cards will switch to charging high interest rates.

It’s also worth noting that the best 0% balance transfer cards are often only available to those with a good or excellent credit history so might not be the best option if you don’t have a good credit score.

0% Money Transfer Credit Cards

0% money transfer credit cards can be a good option if you’re looking to pay off debts such as overdrafts or loans. Money transfer cards allow you to move up to 95% of your credit card limit into your bank account, which you can then use to repay these debts.

Similarly to balance transfer cards, 0% money transfer cards won’t charge you interest for a set period, but will charge a small fee when you transfer money from the card. This is typically between 1-4% of the amount you move.

When considering using a money transfer card to consolidate debts, it’s important to think about whether you’ll be able to pay off the card before the 0% period ends. At this point, you’ll start being charged interest on any remaining balance, which could be expensive.

Savings

This may not be an option for everyone, but if you have savings it could be a good idea to use them to pay down your debts. Even if you don’t have enough to clear your current debts completely, paying off your most expensive debts could be a way of saving you money on interest payments without having to borrow.

In most cases, the interest you’re paying on your debts will outweigh the interest you earn on your savings account, so you’ll be better off paying down any high interest bearing debts.

What are the advantages and disadvantages of debt consolidation loans?

When considering applying for a debt consolidation loan, it’s worth weighing up the pros and cons to see if it’s the best option for you.

Advantages:

  • Lower Repayments – when you take out a debt consolidation loan, you might be able to fix repayments over a longer period, which could significantly lower the amount you pay each month.
  • Easier to manage – Having one, fixed monthly repayment will help you manage your finances. Knowing how much you need to pay, and when you will have paid it off can also bring you peace of mind.
  • Potential savings on interest – If you currently have multiple high-interest debts, consolidating the amount you owe into one lower-interest loan could save you money by paying less interest.

Disadvantages:

  • Could take longer to repay – Fixed monthly payments could mean you spend longer to pay off your debts.
  • Additional fees – Some debt consolidation loans will charge additional fees, such as setup charges. In some cases, this could cancel out any savings you make having a lower interest rate.
  • Could lose your home – Missing repayments could not only damage your credit score, but if you’ve used a secured loan to consolidate your debts, you could potentially lose your home, or any other asset you used to secure the debt.

Debt consolidation loans FAQs

Is a consolidation loan a good idea?

Debt consolidation loans can be a good idea for many, however they are not suitable for everyone. Before applying for a debt consolidation loan it’s advisable to:

  • Shop around to find the best deal.
  • Weigh up the pros and cons of debt consolidation loans to make sure they suit your circumstances.
  • Use an eligibility checker to see how likely you are to be accepted without damaging your credit score. 
  • Explore all of the alternatives to make sure there isn’t an option that suits you better.

Do I need to pay off all of my debts with a debt consolidation loan?

You do not have to pay off all of your debts with a consolidation loan, however it’s a good idea to use the loan to pay off as many debts as possible. One of the biggest benefits of debt consolidation is that you’re only making repayments to one lender, rather than multiple, making your debts more manageable.

Can I get a mortgage after debt consolidation?

In most cases, it’s definitely possible to get approved for a mortgage after paying off a debt consolidation loan. In fact, showing that you are a reliable borrower by making all of your regular payments could help your chances of securing credit in the future.

How do you qualify for a consolidation loan?

Each lender will have their own criteria for determining who they offer debt consolidation loans to. Lenders are likely to look at your credit report, what debts you currently have, and your income. 

It’s a good idea to use an online eligibility checker before applying for any form of credit. This will show you which lenders are mostly likely to approve you for a loan without damaging your credit score.