Marc Crosby 19th Mar 2015No Comments
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A guest article from StepChange.
When you’re dealing with debt, a consolidation loan can seem like a smart idea. The adverts make it sound all so simple: who wouldn’t want to roll all their debts up and make one single monthly payment?
What the adverts neglect to tell you is that debt consolidation can often cost more in the long run. There are also other factors to take into account; these include the temptation to borrow again or that you may be putting your house at risk. That’s why we’d always recommend you consider all of your options before signing the dotted line.
- Why should I be wary of debt consolidation?
- Surely consolidation loans can’t be bad all the time?
- Need more advice on debt consolidation?
Sign Up – NewsletterWhy should I be wary of debt consolidation?
You may feel that we’re being overly cautious when it comes to consolidation loans. After all, rolling all of your debts up into one monthly payment and only having to deal with one creditor seems like a logical choice on the surface. What’s so bad about that?
To help you understand our stance on debt consolidation, we’ve compiled the various pitfalls you need to consider.
- You could be putting your house at risk: Many debt consolidation loans are granted on the proviso that the debt is secured against a property. Therefore, the lender has more chance of getting their money back if you can’t pay – they can seek to repossess your house. That consolidation loan that was meant to fix everything has now become a second mortgage of sorts.
- You may need to factor in broker fees: Some companies offering consolidation loans are loan brokers. This means that they don’t lend you the money themselves, but track a loan down for you with another company. Naturally, this service comes with a fee, which will be added on top of the money you owe.
- You may already be living beyond your means: Many people considering a consolidation loan use credit for daily living expenses. This indicates that their expenses outweigh their income (a red flag is regularly using credit cards to pay for food shopping). Struggling to cover daily costs is a sign that you need free debt advice and not to take out more credit than you can’t afford.
- Consolidating can suggest that you borrow to the max: Quite often, consolidation loans are recommended to people who’ve borrowed the limit of what the banks can responsibly lend. Borrowing to this extent can leave you with debts that can be quite difficult to pay back, especially if you have to deal with an emergency expense or reduced income. It also suggests a tendency to rely too much on credit.
- You might be tempted to borrow again: Once you’ve cleared the balances on your credit cards and overdrafts using the consolidation loan, it’s easy to start using them again. Trouble is, if you were struggling with the credit card payments previously and you were to spend again, you’ll be adding more monthly payments on top of the consolidation loan you now have to cover. It’s not hard to see how things might go awry again.
Surely consolidation loans can’t be bad all the time?
Not necessarily. If you’re struggling, a consolidation loan may be viable in some circ*mstances. However, it’s vital to get clear, in-depth advice on what route is best for you before committing to a loan.
Debt consolidation calculators will often help you find the best deals for consolidating your debts. Our debt consolidation calculator is a little different; rather than persuading you to consolidate your debts, our calculator highlights whether it’s actually a good option for you.
If you do decide to apply for a consolidation loan, don’t over-commit and borrow more than you can afford. Use your budget to help you work out how much surplus money you have.
If it’s unmanageable interest that’s making you consider a debt consolidation loan, moving to a credit card with a long-term 0% balance transfer deal could be better. If you do this, remember, cut up your old card and close your account. Finally, don’t spend ANYTHING on the new card.
Your local credit union may also be able to offer you an alternative to consolidation.
Check out our guide for more detailed information on debt consolidation. For free and anonymous online debt advice, use our Debt Remedy service to put together your own personal debt action plan.
Need more advice on debt consolidation?
- 6 mistakes to avoid when consolidating credit card debts
- Practical solutions for professionally managing a high number of debts
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FAQs
You can afford to repay the loan: A debt consolidation loan will only benefit you if you can afford to repay it. You'll risk getting into a deeper debt cycle if you're not 100 percent sure you'll be able to afford the monthly payment down the road.
Why should you not do debt consolidation? ›
If your credit score isn't high enough to qualify for a lower interest rate, it may not make sense to consolidate your debts. You may also want to think twice about debt consolidation if you haven't addressed the underlying problems that led to your current debts, like overspending.
Is debt consolidation a good way to get out of debt? ›
Debt consolidation is ideal when you are able to receive an interest rate that's lower than the rates you're paying for your current debts. Many lenders allow you to check what rate you'd be approved for without hurting your credit score so you can make sure you're okay with the terms before signing on the dotted line.
What risks does debt consolidation bring? ›
Debt consolidation might lower your monthly payments, make managing your monthly payments easier, decrease your interest rates and save you money overall. But there are also potential drawbacks, such as upfront fees and the risk of winding up deeper in debt.
What is the catch with the debt relief program? ›
Cons of debt settlement
Creditors are not legally required to settle for less than you owe. Stopping payments on your bills (as most debt relief companies suggest) will damage your credit score. Debt settlement companies can charge fees. If over $600 is settled, the IRS will view this debt as a taxable income.
What is one bad thing about consolidation? ›
You may pay a higher rate
Consolidating your debt likely isn't the best move for your finances if you have a low credit score and can't secure a lower interest rate on your new loan. Your debt consolidation loan could come with more interest than you currently pay on your debts.
How much debt is too much to consolidate? ›
Debt consolidation is a good idea if your monthly debt payments (including mortgage or rent) don't exceed 50% of your monthly gross income, and if you have enough cash flow to cover debt payments.
Does consolidating debt hurt your credit? ›
Consolidating your debt can lower your monthly payments, but it can also cause a temporary dip in your credit score.
How long is your credit bad after debt consolidation? ›
Debt consolidation itself doesn't show up on your credit reports, but any new loans or credit card accounts you open to consolidate your debt will. Most accounts will show up for 10 years after you close them, and any missed payments will show up for seven years from the date you missed the payment.
Is debt consolidation good or bad for your credit? ›
Debt consolidation puts multiple debts into a single account to make your payments easier. Debt consolidation can lower your credit score temporarily, but your score will improve if you make payments on time. Other tools like debt management plans and bankruptcy can help you manage debt.
National Debt Relief is the best overall debt settlement company, according to our research. National Debt Relief's low-cost fee structure and referral service make it a top option for people struggling with debts. Our highest-rated debt settlement companies all charge similar fees, ranging from 15% to 25% of the debt.
What is the best debt consolidation company? ›
- SoFi. : Best debt consolidation loan.
- Oportun. : Best for borrowers with bad credit.
- Best Egg. : Best for secured loans.
- PenFed Credit Union. : Best for low rates and fees.
- Laurel Road. : Best for pre-qualification.
- OneMain Financial. : Best for fast funding.
- LendingClub. ...
- First Tech Federal Credit Union.
Bottom line. Debt consolidation can be a handy strategy for paying off multiple debts as quickly (and as affordably) as possible. This can be especially true if the personal loan you use to consolidate your debts doesn't charge you a penalty for paying back the balance early.
How can I pay off 15000 with credit card debt? ›
Here are four ways you can pay off $15,000 in credit card debt quickly.
- Take advantage of debt relief programs.
- Use a home equity loan to cut the cost of interest.
- Use a 401k loan.
- Take advantage of balance transfer credit cards with promotional interest rates.
Be wary of offers to buy lists of government grant programs. They are usually frauds. There is no government program for credit card debt relief. Legitimate debt settlement and relief programs operate by strict rules.
Is it true that after 7 years your credit is clear? ›
Most negative items should automatically fall off your credit reports seven years from the date of your first missed payment, at which point your credit score may start rising. But if you are otherwise using credit responsibly, your score may rebound to its starting point within three months to six years.
Is there a downside to consolidating loans? ›
Consolidation has potential downsides, too: Because consolidation can lengthen your repayment period, you'll likely pay more in interest over the long run.
What should be avoided in consolidation? ›
5 Costly Debt Consolidation Mistakes – and How to Avoid Them
- Locking in the first interest rate you're offered.
- Choosing the lowest monthly payment.
- Borrowing more money than you need.
- Only considering a personal loan.
- Getting caught in a cycle of debt.
Debt consolidation affects your credit scores in different ways, some positive and others negative. The overall impact will depend on your current credit profile, but here's a closer look at the impact on various credit scoring factors: Applying for new accounts can hurt your credit.
