Debt consolidation is a method of streamlining different debts into single debt repayment. At the heart of debt consolidation is the ability to consolidate multiple debts and monthly financial obligations into a single, more manageable monthly repayment or financial arrangement.
Usually, this works by taking high-interest debts, such as credit card bills or payday loans, and putting them together into one lower-interest loan.
This is a way of making loan repayments more straightforward, as there is only one payment to manage. Thus, you are less likely to miss payments and, in some cases, may receive a lower rate.
Why Should You Consolidate Your Debt?
Debt consolidation might be a good idea if you currently have multiple lines of credit and are struggling to meet your minimum monthly repayments.
Having many different lines of credit open can make it difficult to stay on top of your finances as you have to remember what you owe, to who, and when. All of this can lead to additional anxiety and stress. Instead, consolidating your debt can help you make your finances more manageable so that you can work to pay off your debt more quickly.
What Are The Benefits of Debt Consolidation?
There are many potential advantages to debt consolidation that you may want to consider if you are looking to manage your finances better and if you find yourself struggling to manage your repayments.
1. Streamline your debt
When you combine multiple outstanding debts into a single loan, it makes it easier to keep track of the number of payments that you need to make. When your finances are easier to manage, it makes the likelihood of a missed or late payment far lower, which can positively impact your credit rating.
Managing one payment, knowing exactly when this is, and how much can help you get on top of your debt and pay it off more quickly and reliably.
2. Lower interest rates
Depending on the lender, you may be eligible for a lower interest rate on the consolidated loan. This can help you save money in the long run. Often, personal debt consolidation loans have a lower interest rate than credit cards or payday loans. So streamlining high-interest debts into one low-interest payment could be a good way of saving money.
However, this will largely depend on your credit score. For example, if you have a poor credit score, it is unlikely that you will be offered a lower rate. Similarly, it is worth remembering that different types of debts come with different interest rates, and you may not be better off by switching to a debt consolidation loan.
For example, credit cards come with high-interest rates, whereas student loans may have a lower interest rate than debt consolidation loan. Focus on overall savings before making a decision.
3. Repay your debt quicker
If you secure a lower interest rate on your consolidation loan, you could put more money aside each month to make extra payments. This could help you repay your debt quicker and could help you save on interest rates long term.
4. Reduce monthly payments
Debt consolidation often comes with a longer repayment period. This means that your overall monthly payment is likely to decrease as the payments are more spread out. This could be a benefit as it allows for more efficient monthly budgeting. However, you will need to weigh whether or not this will cost you much more in the long term.
5. Improve your credit score
Debt consolidation could help to improve your credit score. Although applying for new loans can cause a temporary dip in your credit score, consolidating your loans into one can also reduce your credit utilisation rate – a key factor of your credit score.
It is estimated that consolidating debt responsibly may help you keep your credit utilisation under 30%, which can positively build your credit. Responsible borrowing is usually looked upon very favourably by lenders, which, in turn, can benefit your credit score in the future. Similarly, making regular, timely payments can also help you improve your credit score over time.
What Are The Risks of Debt Consolidation Loans?
If you take out a debt consolidation loan, it could temporarily harm your credit score as it involves a hard credit check. Therefore, whether you need to borrow £400 or borrow £4,000, always make sure you absolutely need a debt consolidation loan before you go ahead and apply for one.
Additionally, there is always the risk that you will not receive low enough rates for your loan, meaning that it could end up costing you more money in the long term.
Another possible risk of debt consolidation is that you end up with more debt than when you started, so it is always best to approach debt consolidation with caution.
