Consolidating debt is when you take out a single, new loan to pay off several existing debts. This can be a good way of taking control of your finances but you need to be careful. A consolidation loan may not always be your best option.
Before considering a consolidation loan
Before you decide on a consolidation loan, find out what's on offer and what alternatives you've got. These could include:
- trying to make new arrangements with your existing lenders
- checking that you're making the best use of credit options you've already got - such as an overdraft facility, credit or store cards, a personal loan or extension to your mortgage
- borrowing from relatives
You could also take advantage of the free advice that's available from debt counselling services such as National Debtline. (See 'Where to get help and advice' below.)
If you do decide to take out a consolidation loan, shop around for the best terms from a reputable lender. Building societies and banks may be able to offer you a personal loan.
Reasons to consider a consolidation loan
Used carefully, a consolidation loan can help to put you back in control of your finances.
The advantages can include:
- paying a lower rate of interest longer-term consolidation loans may be better value than short-term borrowing
- your monthly payments might be lower
- youll know when you will finish paying off the debt
- you'll only have to make a single payment each month
- you'll only deal with one lender
- you may avoid falling behind on payments and getting a bad credit rating
Possible disadvantages of consolidation loans
Bear in mind that there are some major drawbacks too, such as:
- if the loan is secured against your home, your property will be at risk of repossession if you can't keep up your payments
- you could end up paying more overall and over a longer period
- you'll usually pay extra charges for setting up and repaying the new loan
- if the loans you're consolidating had the interest added at the start, you'll be paying interest on that interest, as well as on the amount you borrowed
- all your eggs will be in one basket - if you get into difficulties, it may be more difficult to come to a new arrangement with a single lender
- you need to be very careful to check you can afford the new payments on the loan
- if you have a poor credit rating, you may only be able to get a loan at a high interest rate
- in the current economic climate it is much more difficult to get an unsecured loan at a low interest rate
- if you dont pay off all your existing debts, you may struggle to make the payments on the new loan on top
How to choose a consolidation loan
Always shop around for the best terms - it will save you money. Make sure you understand all the terms and conditions of the loan, such as:
- how long you'll be making repayments and how much you'll pay back altogether
- the interest rate and whether it can change
- what the monthly repayments are and what happens if you miss one
- whether they will charge you extra interest and charges on missed payments
- any penalties or costs you'll have to pay if you want to repay it early
- what happens if it's secured on your home and you can't keep up the repayments
Once you've arranged the loan, aim to keep your finances under tight control - for example, cut up your credit cards and don't let the debt build up again. Be aware that the lender may put pressure on you to borrow more by extending the loan.
You'll be encouraged to take out insurance with your loan. Make sure you're clear about the terms, that you really need it and that you'll be able to claim on it if you need to.
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