Is it better to consolidate debt or snowball it?

A reader asked about the best way to clear debt:

“I owe about 12k and my partner a bit more. We are well paid but we can’t rely on the bonuses and we want to get a house as soon as possible. What do you suggest? Preferably easy as we both work long hours – please don’t tell me to take sandwiches to work!”

First well done on taking the decision to do something about your debts. It’s pretty easy to run up the credit cards if you have good but not regular bonuses.  Your large debts may be almost manageable at the moment, but jobs do go wrong and suddenly your situation could become much less safe. Or inflation pushing up your costs could push your budget over the edge.

And if you want a mortgage, most of your debts have to go – see Can I get a mortgage with debt?

Your two options – consolidation or snowballing

There are two approaches you could take:

• consolidating your debt so you each have one large loan – this is sometimes called re-financing; or
• snowballing, which is paying the minimum off all your debts apart from one and aiming to clear that one as fast as possible. (Your “snowball” is the amount you overpay a debt each month – this gets bigger as the months go on because you are paying less interest, just as a snowball gets bigger as it rolls downhill and picks up more snow.)

Both these ways assume your current debt payments are manageable – you just want to pay less interest and get the debts down. And they will both work much better if you have an OK or better credit record.

If you can’t manage your current debt, you need to stop thinking about getting a mortgage and get some debt advice.

With too much debt you will never be able to save up a deposit and may not be approved for a mortgage even if you are lucky enough to inherit the money for a deposit. So phone National Debtline on 0808 808 4000 and they can help you look at your alternatives.

Debt consolidation – temptingly easy?

Debt consolidation sounds so simple – exchange all your current debts for a single loan and a single monthly repayment. After a few years, at the end of the large loan, there you are, debt free…

But it’s not so easy in practice.

You may not be offered a large enough loan to be able to repay all your other debts. Even if your credit record is really good, you may be refused if the lender thinks this loan plus your existing debts would be too much. You know you want to repay the other debts, but the lender may reject your application because they can’t be sure you would.

And if you do get the loan, a lot of people clear their credit cards but keep one or two credit cards open “for emergencies. Then over time they just run up the credit card bills again… If your income is erratic, it may seem obvious to use the cards to smooth it out, but that is a slippery slope, it’s how you got your current debts. In a year or two you may find you have the large consolidation loan AND a lot of new credit card debt.

So far from being an easy way forward, a consolidation loan often ends you up in a much worse debt situation.

Don’t consolidate debt with a “bad credit” lender

If you have a lot of high-cost debt already, you should never ever try to take a single loan from a bad credit lender to consolidate it. These are lenders such as 118 Money, Everyday Loans, Likely Loans, TM Advances etc. They may sound cheaper than your current borrowing, but their loans are expensive and go on for a very long time.

As a debt adviser I see far too many people who thought a simple loan from one of these lenders would solve their problems, but it just got them deeper into debt. Here is what one reader said of one of these loans:

I had a loan of £2,000  that I repaid early after 6 months with a loan from my parents to save in interest. It turns out the figures to settle was £1,999.42, despite paying £958.02 to them already I had only actually paid off 58p of the loan, I was gutted.

Read Can I consolidate with bad credit? that looks in detail at this difficult situation.

If going for high-cost loans to consolidate is dangerous, using a logbook loan or a guarantor loan is much worse.

How does snowballing work?

Snowballing is described in detail in this guide. You start by deciding what debt is your top priority – that could be the highest interest or the smallest debt. Then you pay as much as possible off that debt and just the minimums over the others.

When your target debt is clear, you switch to the next target. Keep an eye open for good balance transfer offers to reduce the interest you pay. And if you can reduce your expenses, this will give you more spare money to speed up the snowball.

If you can get a 0% balance transfer, you can turn it into an interest-free loan by repaying a fixed amount each month, which would be a simple way to really kick-start your debt reduction plan.

Unfortunately, in 2021 it’s harder to get a 0% balance transfer and it may only be for a small limit. But if you have a good credit record, it is still worth trying for one. So use a soft-search checker such as Money Saving Expert’s – it will tell you which balance transfers you are likely to be accepted for.

Which will work better?

If your income is secure and fixed and you have the willpower to never use a credit card again and you get a loan offered at a cheap rate, then debt consolidation works fine.

But snowballing is a more flexible, practical approach for most people. In a good month, you can overpay a lot – you could aim to use all your bonuses for extra debt repayments. In a bad month you won’t be able to pay off so much, but you still make some progress.

About those sandwiches…

Of course, you don’t have to take sandwiches to work. Or cancel Sky, go on fewer holidays, give up the gym, hang onto the car for another few years, go out less often or cut back on gadgets and clothes.

But then you don’t have to save up a house deposit, put money away for a pension or plan to have a family either!

Most people, even with good incomes, have to make some hard choices.

Only you can decide what you really want, but make this an informed decision, don’t just drift along. Try keeping a spending diary for the next month and see where the money goes, then decide if you want to make any changes.

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