Should I consolidate my debt into one manageable lump?

By Natasha Culzac
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You’ve probably heard the phrase ‘Debt consolidation loans’, is it just a fancy phrase for ‘loans’? Could one help you?

giffgaff member and writer Natasha Culzac sheds some light on ‘Debt consolidation’, is it a simple loan that makes all your debts miraculously disappear? Here she explores what it is, and most importantly shares what you need to know before considering it.

Natasha says...

We’ve all seen the ads, they promise us: “simply consolidate your debt into one small, monthly sum”. Somewhere, there’s a new graduate sitting in their pants in the mid afternoon, watching the fourth consecutive episode of Judge Judy screaming: “Yes! Why didn’t I think of this earlier?”

But it’s never that easy, is it?

What is debt consolidation?

It’s a way of reducing many threads of debt into just one. If you were struggling to keep on top of the payments for, say, two credit cards, an overdraft and a catalogue account, you could take out one large loan and pay them all off, now only paying a monthly instalment to one creditor instead.

Consolidation is a very tricky business, so before you get excited about being wired thousands of pounds, there are a number of things you need to be aware of.

1. The very act of consolidation often costs money

“If you’re consolidating to cut the interest you pay, watch out for any additional charges,” Caroline Hamilton, Debt Expert at Money Advice Service, says. “Your original lenders may ask for fees or additional costs for switching your debts, and some companies charge for consolidating your loans.”

If you get the help of a private financial adviser this will also incur a fee, as could paying off any existing loan arrangements – with your new wad of cash – early.

2. Bills, bills, bills

Despite fees, the main benefit of consolidating is that you reduce your monthly outgoings. If you’re overwhelmed with credit repayments and feel like you’re in financial purgatory, it’s potentially worth considering.

Add up what you pay back each month on credit cards etc and see whether a large loan’s repayments will cost less than this i.e – that you can actually afford to keep up regular payments.

Paying the minimum on a credit card is a bad idea. It will literally take you forever to clear it - if you want a shock, use this calculator to see exactly how long. Because of this, a consolidation loan could help as the APR may be lower than that of a card, and could also mean that you have more of your pay packet to play with each month.

For example, imagine you take out a £7,000 loan with a 6% APR to be paid over five years. You’ll pay back roughly £135 each month and at the end of the five years have paid about £1,120 in interest (£224 each year). Of course the exact figure will depend on the exact deal you arrange with your lender

However, there’s a flip side: in order for the repayments to be small, the term of the loan could be quite long and the overall interest could cost a lot.

Independent Financial Adviser, Paul Bird, of Grosvenor Corlett Bird, says: “Normally the biggest drawback of debt consolidation is either the large arrangement fees or the likely longer term nature of the arrangement which will cost much more in interest payments, plus tie the person down for longer and in so doing may make it harder to get future credit.

“It is essential to weigh up the short term gain against the longer term cost and consequences.”

Be aware that if you consolidate to a 0% introductory type deal, the interest you pay afterwards could be high and you may not be able to swap to something else. To know more about 0% balance transfer card, you can click this nifty link. 

Also that if you do take out a loan, you should close down the paid-off debts immediately. “Once you’ve consolidated, you’re likely to still have access to your old lines of credit and if you continue to use these, you could run this risk of amassing an unmanageable level of debt,” adds Ms Hamilton.

3. Secure or Unsecure, that is the question

Broadly, a loan’s interest rate can be in one of two sectors: secured or unsecured. Someone with a secured loan has usually taken it out using their home as security against it. Because the lender knows it can repossess the home should the borrower default on repayments, the interest rates are normally lower than that of an unsecured one.

Let’s face it, who owns a house these days anyway? If you’re looking up loans, it’s likely to be of the ‘unsecured’ variety and this means that the interest rates will be higher – credit cards and personal loans often fit into this category.

4. Are you ready? (Said in the style of Gladiators, by the way)

Alexander House , the professional financial advisory service recommends checking your credit score with a reputable organisation before exploring loan options, because this will affect the terms you’re offered. You’ll want to have an acceptable rating, have a working bank account within agreed overdraft limits and have no missed payments, defaults or County Court Judgements, in order to get the best deal. The exact criteria will differ between different lenders, but these are the main ones to look out for.

5. Have you explored other ways to clear this debt?

You may be able to negotiate new arrangements with your current lenders, for things like smaller repayments. You could even ask your lender to write your debt off., though this should be seen as a last resort. If you do find yourself struggling with repayments the first thing you should do is contact the lender. The Citizens Advice Bureau (CAB) can help with existing debt, as they can work as a negotiator between you and your lender. Speak to somebody in person at one of the CAB’s offices around the country.

 

Try getting a quote for a consolidation loan to see whether the overall costs are worth it. Be aware of interest and fees, including arrangement charges and those relating to the early repayment of the credit you’re closing.

Got any other phrases/ terms you’d like us to demystify, let us know in the comments below.

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