Lots of people want to consolidate all their debts into one loan.
Making just one monthly payment sounds simpler. And the interest could be lower – a big improvement, surely?
Consolidating can sometimes be a good idea, but you have to be careful to get it right. Most debt advisors have seen this go badly wrong for too many clients…
So if you want to get this right, here are the five big pitfalls that you need to avoid.
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1) NEVER leave credit cards open
This is the biggest mistake and also the most common. Don’t fall into this trap!
If you leave a credit card or a catalogue account open this, at some point it may feel convenient to use them.
Perhaps you mean to pay it all off quickly, but other urgent problems may arise and soon your debts are rising again and you still have most of the big consolidation loan to pay off…
So some people try to consolidate again. This time you need to borrow more and the interest rate will probably be worse, or you may just be rejected.
If you want to keep some credit as a safety net, you could just keep one card for emergencies, but reduce its limit to less than £1,000 and set it up to repay in full automatically each month.
2) DON’T borrow for longer than you have to
If you borrow for a longer term the loan may feel “cheaper” because the monthly repayments will be lower. But overall a lot more interest will be charged.
If you borrow £9,000 over four years at 8% then the monthly repayments will be £219. If you stretch the term to six years, the monthly repayments fall to £158 but the interest total goes up by over £800.
Not only will you be paying more interest, but you will be stuck with the consolidation loan for longer.
If you want to save up for a house deposit or increase your pension contributions or start a family, you are postponing the time you can get on with the rest of your life.
3) DON’T consolidate cheap debt
The main gain from consolidation comes from reducing the interest. So if some of your debt is already cheap, don’t include it in the consolidation just to get one payment a month.
That simplicity isn’t worth the fact that you will be paying more interest!
And if you have a current large loan that only has a short while to go, don’t re-finance this as you will then be paying interest on it for a lot longer. Try to get through the rest of the loan, then your monthly finances will improve massively.
If you aren’t sure about this, ask for a settlement quote on that large loan that finished in the next year… Interest is usually front-loaded on loans. You may be disappointed at how little you actually save by settling it now.
4) AVOID a secured loan
If you need to borrow a lot of money, then the only way you may be able to do this is with a secured loan on your house. Think long and hard about this – it is very often a big mistake.
If you have financial problems in a year or two, then there are ways of handling unsecured debts. They could all be offered a token £1 a month payment until you get another job. But if you have turned your unsecured debts into a secured loan, you may lose your house.
When you have to claim benefits, you can get help with mortgage interest after a few months, but no help with secured loan repayments.
If the only secured loan you can get is from a sub-prime lender, it will usually be a variable rate. These lenders have a nasty habit of increasing this rate even if other interest rates stay the same.
5) Expensive “bad credit” loans are a DISASTER
If you have a bad credit record and some consolidation loans offered are actively dangerous.
- a logbook loan is secured on your car.
- a guarantor loan can turn into a nightmare because you are desperate to stop the lender going after your relative or friend if you have problems.
- “bad credit” loans from lenders such as 118 Money, Everyday Loans and Likely Loans can charge 25% or more.
The interest on these loans is so high that they don’t solve your problems, they make them worse. So you are more likely to run into difficulty.
It may feel OK for a few months then you will be struggling again. Many people end up having to get a second top-up loan as they can’t afford the repayments on the first loan.
When your situation is so bad that you are thinking of one of these loans, it is better to stop and get some debt advice instead. You can think of a debt management plan as a consolidation loan where you make a single payment each month, which can change if your situation changes, and interest is frozen on your debts…
So be a smart borrower!
If you avoid all these traps, then a consolidation loan may help reduce your interest.
But look at your other options first.
If making a few cutbacks now will reduce your expenditure then you may be able to afford to clear your debt faster without needing a large loan over a long period. Cheap debt is better than expensive debt – but no debt at all is even better!
And if you have a good credit record, look at 0% balance transfers. You couldn’t get a 0% deal for all of your debt, but you may be able to get a smaller offer that will really cut the interest you are paying. There are some good offers around in 2021, not as brilliant as they were a few years ago but well worth grabbing, see a best balance-transfer table.
If you already have high-cost debt, look at affordability complaints. They can cut your balance or even get a refund!
Payday loan interest rates sound astronomically high but they are “capped”. If you borrow £500 you can never pay more than £500 in interest. If you consolidate a payday loan with a loan at 50%, that only sounds cheaper because it isn’t capped. Over the years you can end up paying much more in total interest charges.
What about a flexible 0% consolidation loan?
Sounds perfect? These do exist for people who can’t manage their current debt repayments.
They are called Debt Management Plans! They are flexible as you can reduce the monthly payments or increase them depending on how things go.
Interest isn’t guaranteed to be frozen in a DMP, but it almost always is – see what to do if a creditor won’t freeze interest.
Your credit record will be harmed by a DMP, but it gets your debts paid off as fast without insolvency.
If you have too much debt now, but could cope if interest was frozen, a DMP can be a very good option. Too often taking out an expensive consolidation loan only puts off the day when you have to get help.
Talk to StepChange on 0800 138111 about the pros and cons of a DMP – they run DMPs where you pay no fees and all your monthly payment is divided up between your creditors.
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Julia says
As a provider of ethical finance, we get a lot of applications for consolidation loans and we do consider them very carefully to ensure that they’re a good deal for us and for the borrower.
I would expand on DC’s final paragraph and encourage you to consider what caused the debt in the first place. It might be that you had a short-term problem or an unexpected bill, that there was less money coming in for a while – if you could just reduce the interest you’re paying you’d be fine and a consolidation loan might be a good option (taking points 1-5 into account).
If, however, you’re in debt because you are spending more money each month than you are getting, then borrowing to pay off the existing debts isn’t going to solve the problem. In fact, it has the potential to make it much, much worse. I’m not being judgemental, it’s up to the individual how they spend their money, but if they’re asking me as a lender to take this on, I will look at this.
If this has been the issue and you really want to improve your situation, you’re either going to have to reduce your spending, increase your income somehow or accept that you’re going to need credit to cover the shortfall. This credit may be expensive and in the long term might not be enough.
There are some excellent budgeting tools and support available, I’d always suggest that taking an honest look at your financial situation is an essential first step – you might find you don’t need to borrow at all.