Is consolidating your debt a good idea?
A debt consolidation loan will mean you only have one company to pay back each month. It can help you manage your budget better if you only have one monthly payment to take care of.
People also consolidate credit card debt by moving the balances to a lower interest card to try and reduce the total amount they will pay back.
It sounds simple, but there are hidden risks that could make your situation worse. The way you deal with debt should make your life easier, not harder.
It means taking out new credit
Signing up for a debt consolidation loan means you are taking out a new credit agreement and using the money to “pay off” your debt. The debt does not disappear though, as you will now have to repay the new loan. There will be new terms and conditions to understand. And there may be other charges like set-up fees or early repayment fees.
An arrangement fee is a charge by the lender for setting up a loan or financial agreement. It is like an admin fee to look through your application and set up documents.
Can you really afford the repayments?
The monthly repayments for a single loan may be smaller in some cases, but you might end up paying off the debt for longer or paying more interest in the long term. People often take out loans because they cannot afford day-to-day costs.
If your monthly repayment means you still cannot afford essential things like food and clothing, then consolidation is not going to help you. There is a risk you may need to take out more credit while still paying off the first loan.
Consolidation cannot fix debt problems alone
It can make people feel like they are in control of their finances by joining lots of debts together. But a consolidation loan does not stop you from needing to take out more credit later on. And it will not solve the deeper reasons why you have debt that is hard for you to manage.
There are other ways to feel more in control of your debt than taking out a loan. Use our debt consolidation calculator to find out if debt consolidation or debt advice is right for you.
Debt consolidation or debt management?
Debt consolidation and debt management are two different things.
- Debt consolidation means you are taking out new credit to pay your debts
- Debt management is where you, or a debt management provider, agree affordable payments with the companies you owe money to. Sometimes the debt can even be written off
Managing your debts can be in the form of a formal debt solution, like an individual voluntary arrangement (IVA). Or if you live in Scotland, there is the Debt Arrangement Scheme (DAS).
Or there are informal solutions like a debt management plan (DMP).
A DMP has some of the same benefits as consolidation:
- One monthly payment that goes towards all your debts
- Fewer creditors to deal with as the DMP provider will speak to them for you
The main difference is that DMPs do not involve taking out further credit. Instead, creditors usually agree you can make smaller payments to your debts, based on what you can afford to pay.
There is the possibility of interest and charges being frozen too, if your creditors agree. And, DMPs are flexible. So if your circumstances change, your budget can be changed too.
Many debt management companies provide DMPs, but some charge fees. Our DMPs have no set-up charges or monthly fees. All the money you pay goes towards paying off your debts.
If you live in Scotland, a debt payment programme (DPP) also gives you extra protections against enforcement action and stops interest and charges.
Find out more about the differences between debt consolidation and debt management.