The Pros and Cons of Debt Consolidation Loans: Is It Right for You?
Struggling with multiple debts is hectic. Are you in a similar situation too? Have you tried to merge all the money you owe into a single loan? If the answer is no, then you could look to try an effective new solution for your debt repayments.
To understand if debt consolidation is the right path for you, we must thoroughly review its pros and cons.
What is A Debt Consolidation Loan?
Debt Consolidation means merging all your debts into one loan.
It is a way of repayment in which you will repay a fixed amount every month. For this, you borrow money from one lender to pay all your debts so that you owe only a single lender.
Debt Consolidation has two types:
Secured debt consolidations are the ones that are secured against an asset, whereas unsecured debts are the ones that are not guarded by any valuable asset. Debt consolidation loans guaranteed against your home are termed homeowner loans.
Pros of Debt Consolidation Loan
Following are the pros of debt consolidation, which make it a beneficial way to get out of debt:
- Debt consolidation loans can help streamline finances, decrease payments and improve credit scores.
- Debt consolidation loans have the potential to save on interest rates and merge all debts into one payment.
- Paying extra or aiming for shorter terms could mean more savings in the long run.
- Reducing the amount used compared to available lines of credit and making regular payments helps improve credit scores.
Cons of Debt Consolidation Loan
Taking out a debt consolidation loan can be beneficial in terms of reducing monthly payments and simplifying bill payments. However, it is important to be aware of the potential drawbacks.
- Extra fees such as origination charges or balance transfer costs may apply.
- Over time, consolidating debts may result in increased overall interest and longer payment periods.
- Missing payments or defaulting on these loans will result in a ding on your credit score and potentially additional fines.
Underlying issues still prevail even after getting relief in the form of debt consolidation loans. They need to be addressed, as does any temptation towards excess spending.
Consolidation Loans When You Have Poor Credit
Poor credit scores can make it difficult to obtain a loan. The same applies when looking for a debt consolidation loan. If your credit history features records of missed payments and defaults, CCJs or a previous history of IVAs and bankruptcy then you will likely pay a much higher interest rate. If you believe this applies to you, be careful that the debt consolidation loan doesn’t result in paying more interest vs your current creditors.
When Should You Consider a Debt Consolidation Loan?
Debt consolidation can be a great way to reduce interest payments and get back on track financially. However, there are important things to consider first.
Be sure that any savings you make aren’t wiped out by fees. This is often overlooked by people taking out a debt consolidation loan. For a debt consolidation loan to be effective, you need to calculate how much you are paying in charges across your debts. Compare this figure against the interest you will pay on a debt consolidation loan.
The loan should be affordable for repayment over a long period of time. You need to make sure the loan won’t increase in the future due to fluctuating rates or life changing events like losing employment or ill health.
We also advise that you speak with an expert who could give tailored advice specific to your situation. There could be other debt solutions that fit your specific situation better than a debt consolidation loan. For example you could look at an IVA or debt management plan, don’t look to tackle your debts alone.
Charges of Debt Consolidation Loans
If you’re considering taking out a loan, keep an eye on the fees! Before signing anything, make sure to carefully read through all of the small print and check for any extra charges.
Also, double-check if there are any penalties you need to pay off your existing loans early.
Finally, avoid shelling out cash just for someone else’s help setting up the loan!
Alternatives to Debt Consolidation Loans
Choosing the right debt consolidation option can be tricky! Before making a decision, it’s important to weigh your options carefully. Debt Consolidation Loans are unsecured personal loans with tight eligibility requirements and may only sometimes cover larger types of debts.
Other options are:
Balance Transfer Cards
Balance transfer moves a balance from a credit card or loan to another credit card. If one of the cards has a much higher annual percentage rate (APR) you can use the balance from a lower APR card to save you money.
Let’s say you have a debt of £5000, all of this debt is on a credit card with a 15% APR rate. If you can transfer this balance to another card that offers a much lower APR (potentially 0% APR on introductory cards). Over the period of paying off your debt, this will save you money in interest charges. Here is a small example of how this works:
Credit card @ 15% APR – Total to pay £5415
Balance transfer card @ 0% APR – Total to pay £5150
Home Equity Loans & HELOCs
Home equity loans and HELOCs allow you to borrow against home equity. Your equity will be the difference between what is owed on your mortgage loan and the properties current market value. In most cases, It is possible to borrow up to 85% of your home equity. However, if payments aren’t made on time, there is a risk of losing property.
Individual Voluntary Arrangement
An Individual Voluntary Arrangement (IVA) can help consolidate your debts into one streamlined payment. An IVA is a government regulated scheme and is legally binding, meaning that once you are within an IVA your creditors have to respect the terms. IVAs typically run for between 5 and 6 years and after the term you could write off up to 81% of your debt. However, no matter who arranges the IVA there will be fees and costs involved.
Debt Management Plan
Debt management plans are very similar to IVAs, they help consolidate your debts into one monthly payment. A Debt Management Plan will typically last for between 3 and 5 years. DMPs are informal agreements meaning they are not legally binding – unlike an IVA your creditors do not have to stick to the terms, they are not obliged to stop contacting you.
Bankruptcy offers relief from medical bills etc, yet carries steep consequences such as major hits to credit scores which can last years down the line. It pays off (quite literally) to do intense research around all these solutions before opting in any direction!
If you’re in a sticky financial situation, debt consolidation may be worth looking into. However, you want to do your due diligence before jumping at the chance! Weighing up both sides of this strategy is vital. So, consider the possible benefits and any associated drawbacks. Consolidating debts may move you closer to making your goals a reality!