Lots of people want to consolidate their debt into one loan. Making just one monthly payment and paying lower interest sounds simpler and cheaper – a big improvement, surely?
Consolidating can sometimes be a good way to reduce the interest you are paying, but you have to be careful to get it right. Most debt advisors have seen this go badly wrong for too many of their clients… so here are the five big pitfalls that you need to avoid.
1) DON’T leave credit cards open
This is the biggest mistake and also the most common. Don’t let it happen to you!
If you do this, then at some point it is likely you will use the cards again. Perhaps you mean to pay it all off quickly, but other urgent problems may arise and soon your credit card debt is rising again and you also have the large loan to pay off… and the next time around you probably won’t be able to consolidate as the loan required would be too large.
Perhaps keep one card for emergencies, but reduce its credit 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 £9000 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 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. New mortgage-lending rules have made it much harder for you to get a mortgage if you have debts.
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! Also if you have a current large loan that is costing you a lot each month but only has a few months to go, don’t re-finance this as you will then be paying interest on it for a lot longer.
Look at your expensive credit card debt and think how you could tackle that. One option might be to get a 0% balance transfer for it. 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 very good offers around at the moment, see MoneySavingExpert’s best balance-transfer table.
4) DON’T get 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. Don’t do this! It is almost always a big mistake:
- if you have financial problems in a year or two – perhaps one of you loses their job or becomes ill – then there are ways of handling unsecured debts. If you have turned your unsecured debts into secured loans, then you may lose your house.
- if you have to claim benefits for a period, you will get help with mortgage interest after a few months, but you will not get any 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 a lot even if other interest rates stay the same.
In 2018, the FCA (who regulates lenders) was looking at secured loan firms, worried that they are lending too much without proper checks. Shawbrook, a big lender to this sector, admitted it was under investigation and two of its directors have left. There are also reports that some brokers are reportedly charging borrowers second charge completion fees of up to 10 per cent.
5) AVOID expensive “bad credit” options
If you have a bad credit record and you want to consolidate debt, you may be looking at some loans which are actively dangerous.
A logbook loan is secured on your car. A guarantor loan is “secured” because the lender will just go after your relative or friend if you have any problems. These sorts of loan also charge very high rates of interest – 40%, 50% or even more. The “bad credit” loans from lenders such as 118 Money, Everyday loans, Likely Loans, Avant Credit can charge even more.
The interest on these loans is so high that they don’t solve your problems, they make them worse. 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.
If your situation is so bad that you are thinking of one of these loans, you need to stop and get some debt advice instead. If you already have high cost debt, look at affordability complaints as a way to reduce these – or even get a refund! See
- How to get a payday loan refund;
- How a borrower can ask for a refund for a guarantor loan;
- How to ask for a refund from large bad credit loans including logbook loans.
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 (ditch Sky? fewer takeaways?) 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 can’t manage your debt repayments, talk to a trustworthy debt adviser about your options. Because more debt isn’t the answer.