Using a loan to consolidate your debts into one payment has become an increasingly popular way to simplify finances. A report released by Sainsburys in February estimated that nearly £1.5bn would be borrowed specifically for debt consolidation in the first quarter of 2012 and a total of almost 160,000 loans.
Borrowing more money to pay off existing debts can be a risky strategy, however, and there a few things you should take into consideration before you sign up for a loan.
Here are four things you should be aware of before consolidating debt, to make sure it is the right decision for you:
- It can take longer to pay off debts. When consolidating debts, one of the primary benefits is that the monthly payments are lower and more manageable. The flip side to this is that it could take you longer to pay off the debts and for some people, they could afford a little more if they did a full budget analysis to see where their money was being spent.
- You pay more interest. If the loan goes on longer, you could pay more interest than if you repaid your debts seperately. This depends entirely on your existing debts though as some credit cards are much higher in interest. However, could you transfer the balance to a 0% card to make it even cheaper than a consolidation loan?
- There is the risk of increasing your debt. Using a consolidation loan to clear your existing debts will leave your old credit cards, overdrafts and flexible loans with available balances and if your budget isn’t correct, your cash flow isn’t stable or your mindset to get out of debt isn’t strong enough, it could be very easy to use these lines of credit and worsen your debt situation further.
- You might not be accepted. If you have a need to consolidate debt, then it is more likely that you have struggled with payments, missed payments or even had debt passed to collection agencies, then you might not get accepted for the loan. Before attempting to consolidate, your income and expenditure should be written out and analysed for places you can cut spend. Focus on making regular payments before attempting to get more debt which could damage your rating further.
Used wisely, debt consolidation can be an extremely powerful debt reduction option, but it entirely depends on your personal situation as to whether it is the best option.
As with anything, it is a tool that can work but only if it is used the way it was intended. Your income/expenditure, budget and monthly cash flow all need to be in order before this type of loan should even be considered.
If you’re struggling to figure out how to keep your finances under control, consult a financial professional as soon as possible. Many companies offer free advice and will help you to manage your debt better so that a consolidation loan will work for you if you decide to take that route.
Ian is a finance blogger who writes on personal finance, debt, and money making at debtconsolidation.org.uk
Editor Money Smart Magazine and author of The Financial Fairy Tales - award winning books teaching children about money, enterprise and the business of life