What is a debt consolidation loan and how does it work?

Debt consolidation means combining several debts into one, so you only have to pay off one single sum.

That can mean make it easier for you to get to grips with your debts and, at the same time, reduce your monthly payments.

There are two main types of debt consolidation loans: 

• a secured loan, linked to an asset such as a property
• an unsecured loan, which isn’t connected with anything you own, but often carries higher interest rates

Imagine you have three separate debts, each with their own different interest rates and payment deadlines.

It can sometimes be hard to keep track of them all, and that’s how you can end up making mistakes, such as missing payments.

But by combining these into one loan, you only have one monthly payment to think about.

That can mean it’s easier to stay on top of your repayments, and you might potentially pay less in interest, although the overall amount of debt won’t be reduced.

A debt consolidation loan covers most non-priority debts such as:

• credit cards
• payday loans
• store cards
• overdrafts
• personal loans

Although debt consolidation might not be right for everyone, it can have several plus points.

For example, you’ll only have to think about one payment, not several, and that can be good for your peace of mind.

You’ll also be less likely to miss payments, and therefore less likely to be hit with penalties such as late payment fees.

At the same time, a single monthly payment could help you lower how much you pay overall, especially if you get a lower interest rate.

And if you manage to make your repayments on time, you could improve your credit score.

But it if you’re already struggling to manage debts, it might not be right for you, and it could instead be worth speaking to us for debt advice so we can discuss other possible options.

Some of the benefits we discussed earlier aren’t guaranteed.

For example, if the loan term is longer, you could end up paying more in interest than you might have done otherwise.

And the interest rates you’ll be charged will be based on your credit score.

So if your score is low, payments could be unaffordable and you could end up paying back for longer.

And if you have a poor credit history, debt consolidation might not even be an option at all.

You’ll also need to compare the ‘total amount payable’ to what you’re expected to pay currently to determine if it’s a worthwhile option, and factor in fees for early repayment of personal loans.

It’s also important to stress that secured loans put your assets at risk, so if you fall behind with your payments, you could lose your home.

So, in short, debt consolidation could make your situation worse.

Use our budget calculator to check how affordable this approach could be for you.

It’s possible, but we wouldn’t recommend it.

If you continue using your credit card, you could end up with more debt on top of your consolidation loan and make your situation worse.

Some lenders may even expect you to close your credit card when you take out the loan.

If you still feel you need to rely on credit even after taking out a debt consolidation loan, then it may suggest you can’t afford to repay your debts.

In that case, you should:

• review your budget
• Find out what benefits you might be eligible for
• Seek debt advice

You should also check out our handy guide on what to do if you’ve got a negative budget. 

In the short-term, you might see a small dip in your credit score after you apply for a debt consolidation loan.

And, of course, it could be hit if you miss or make late payments.

But if you repay your loan on time, your credit score could ultimately end up being higher.

No.

A debt management plan differs from a debt consolidation loan in that payments are based on what you can afford, rather than being set by the interest rate, term and amount borrowed.