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What’s a debt consolidation loan and how does it work?

Debt Consolidation | Guide

A debt consolidation loan could help you if you’re finding the cost of your debt repayments a problem but feel you could get them under control if you could simplify the whole process by making just one payment each month.

Debt consolidation may also be an option to reduce the interest rate you pay or to give you a final date when you know all your debts will be repaid.

If you’re considering a debt consolidation loan because you are struggling to meet your current debt repayments, another solution could be more suitable – speak to a debt expert about your situation and they’ll be able to advise on your individual circumstances.

A debt consolidation loan allows you to use new credit to pay off existing credit. So, if you’re currently paying a number of lenders each month, you could take out a debt consolidation loan, pay off your existing debt with it, and then make just one manageable payment per month towards the new loan.

If you choose to repay this new loan over a longer period of time, your monthly payments should be less than you currently pay each month, so you should find them more affordable. However, because you will be paying interest for longer, this can increase the total amount you’ll pay overall.

Which types of debts can I consolidate?

With a debt consolidation loan you can technically consolidate any kind of debt - both secured and unsecured. There are a few things to consider, though, which we’ll cover below.

What do I need to consider?

Debt consolidation loans can be useful in some situations, but can include extra costs, which is why it’s best to make sure you understand the true cost of any loan or speak to an expert about your individual circumstances to make sure it’s the right option for you.

When taking out a debt consolidation loan, you need to be sure that you can realistically afford to make the new payments, otherwise it won’t help you. This is particularly important if you’re looking at a loan that’s secured against your property, as if you do not keep up the repayments, it could be repossessed and you could lose your home.

If your credit rating is poor, you may not be eligible to take out a loan, or you may be offered one with a higher interest rate, meaning you could end up paying significantly more overall.

You may also be tempted not to include debts with a lower interest rate than the debt consolidation loan. However, the idea of a debt consolidation loan is to simplify and help you to manage your payments each month, so by not including these debts, you may not actually be helping your situation and the loan may become unaffordable if you still have other lenders to pay. It’s also good to be aware of any early repayments charges too, which you’ll sometimes have to pay if you want to repay some forms of credit back before the end of its original term.

You need to be sure not to borrow more than you need, as if you do, you’ll just be adding to the amount that you already owe. You also need to make sure that once you’ve paid off your existing debts with the debt consolidation loan that you don’t borrow more money, or use credit or store cards, for example, as the credit becomes available to you again.

Next: Do I qualify for a debt consolidation loan?

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