Struggling with debt? Four ways a debt consolidation loan can help

Personal debt in the UK has increased by a staggering £63.7 billion since September 2020, with the average household owing nearly £63,000 according to The Money Charity. While most people feel they can balance their finances, many are feeling overwhelmed, Citizens Advice is currently dealing with almost 2,000 debt issues each day. It’s therefore no surprise many are looking for a way to get a handle on their finances. That’s where a debt consolidation loan could be the answer.

A debt consolidation loan is where you take out one, larger loan to pay off all your other debts, leaving you with just one more manageable repayment each month. It’s often used to simplify finances and get borrowers back on the straight and narrow if they’re struggling to keep on top of their debts. Here are four ways they can help.

1. Fast track your way to becoming debt-free

It can be easy to get into the habit of only paying the minimum monthly repayment on credit cards, usually only five per cent of the outstanding balance. Doing so means it’ll usually take decades to clear the balance, while being charged a considerable amount of interest along the way. You’ll also always have access to whatever credit limit you have left, leaving you in danger of continuing to spend on the card and never actually reducing what you owe.

Similarly, many people get so far into their overdraft that sometimes, even after they’ve been paid, they don’t get out of it. In this situation, it can be hard to justify asking your bank to reduce your overdraft limit if this will leave you struggling for the rest of the month. What’s more, if you accidentally go over your arranged overdraft limit, most banks charge a penalty and a higher rate of interest, making it a costly situation.

Consolidating your debts into one loan means you’ll have a fixed end date in sight, so you’ll know exactly when you’ll become debt-free. Providing you can keep up with the repayment schedule, knowing when your debts will be paid off can be a huge financial-stress reliever.

The rate of interest charged is usually much lower than that of a credit card, and spreading the repayments over time can mean those payments are lower and more manageable. However, there are usually fees attached to these types of loans and different providers charge different rates, so it pays to shop around.

To get an idea of how much you might need to borrow, and for how long, the experts at Loan.co.uk have a very useful debt consolidation calculator.

2. Only deal with one repayment

If you’re managing several lines of credit, one of the things you’ll have to manage is multiple repayment amounts and times. While this is often made easier by setting up a direct debit for the amount you need to pay, you still have to make sure you have enough funds in your bank account to cover every transaction.

This is where many run into trouble: they either don’t have enough money to meet all the direct debits they’ve set up, or they have so many repayments to make at different times it’s easy to forget what you owe where. The problem with missed or late payments is that they usually incur a fee, on top of the interest you’d usually pay, increasing debt further. Add to that the damage it causes to your credit score, and it’s not hard to see why multiple repayments can soon become a serious issue.

A debt consolidation loan comes with the benefit of just one repayment, for a set amount, at the same time each month until it’s paid off. It’s common for people to set up a direct debit for this payment to be taken automatically from their bank account shortly after payday. This means they can be confident they can repay the right amount, at the right time, month after month.

Another benefit of only having one repayment is making day-to-day living more manageable. Without having to keep track of so much, it should be much easier to see how much disposable income you have each month and much less stressful on you and your finances in general.

3. Potentially get lower interest rates

Most debt consolidation loans will fall under the umbrella of “homeowner” or “secured” loans, meaning your home will be used as security against the amount you borrow. Because of this security, there is less risk to the lender, who will therefore be more likely to offer you more favourable interest rates.

This can be especially useful if your debt is spread across multiple lines of credit. In particular, payday loans, overdrafts, and some credit cards carry some of the highest interest rates around. If you’ve only enough money to pay the bare minimum back across these kinds of credit, and if the interest rates are high, it could take you decades before you’re able to pay them off completely.

By getting a debt consolidation loan with a lower interest rate, you’ll find that more of the repayment amount will go on actually reducing the debt, rather than on the interest.

Keep in mind, you usually take a debt consolidation loan out over a longer time than an unsecured loan. While the interest rates might be lower, you could pay back more interest overall. However, this is often worth it if it makes day-to-day living much easier.

4. Improve your credit score over time

If you’re struggling to manage your debt and you’re liable to make late payments, or worse, miss payments entirely, it could really harm your credit score. Any missed or late payments will be recorded on your credit report for six years, meaning even if you’ve long since cleared your debt, you could still be reeling from the effects for years to come.

What’s more, if you repeatedly fail to keep up with your repayments, you may find your lenders take further steps to get their money back. This could include legal action, which could land you with a CCJ (County Court Judgment) or IVA (Individual Voluntary Arrangement).

These will also remain on your credit report for six years, but can make it almost impossible to get approved for further lines of credit. While it might be best not to borrow more money while you’re paying off your debt, it could also affect much more ordinary, day-to-day things, like renting a property and getting a mobile phone contract.

Paying off your creditors and closing your accounts with them by using a debt consolidation loan is a great first step towards improving your credit score. Then, providing you can keep up with your repayments on your debt consolidation loan, you’ll demonstrate to lenders that you’re a responsible borrower who can manage credit well, which can go a long way towards improving your credit score.

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