A reader asked:
Are there debt consolidation options for really bad credit? I have a lot of debt and I’m not sure how to start getting out of it with a suitable loan or a credit card.
A credit card won’t work
There are some of “bad credit rating” offers at the moment but they are only for 6 months and you will only get a very small credit limit. And after the six months, the card interest rate becomes very high. They are unlikely to be of much help to you.
You won’t get a 0% balance transfer offer for a longer period or a larger amount unless you have a good credit rating.
So a credit card isn’t going to work as a way to consolidate debt when you have bad credit.
It’s hard to get large consolidation loans even with good credit
This often puzzles people. One reader asked:
why with a good credit score am I turned down for the consolidation loan that would allow me to breathe?
Suppose you currently have £30,000 of debt with half a dozen lenders – an average of £5,000 per lender. Those lenders are happy to take the risk that you won’t be able to pay them for those smaller amounts.
But it’s unlikely any lender will want all that risk with a single £30,000 loan to you. Even if you know you can pay it now, they are still taking the chance that you won’t get sick or lose your job. Or be unable to pay if your rent or mortgage goes up. Or that you would take the big loan and only clear half of your debts and spend the rest…
High-interest consolidation loans
If you don’t need such a huge loan, there may be bad credit lenders prepared to lend you £5-10,000 at interest rates from 25-100% APR or even more.
These are normally a really bad idea.
It may sound good to clear a lot of debt, possibly including payday loans, and just have one single monthly payment to make. But you are locking yourself into high interest for years. In a few months you may struggle to repay the consolidation loan.
And consolidating doesn’t just spread your payments over longer, it also adds a huge amount of interest. An example:
- you get a consolidation loan of £6,000 over four years at an interest rate of 48%. Your debt leaps up to £12,100 and you repay £251 a month;
- if you go for five years to get the repayments down, the interest is a lot more – you will be repaying c. £13,900 at £231 a month.
You end up repaying more than the amount you borrow.
It is illegal for a payday loan to do that – it would break the “payday loan price cap” brought in a few years ago. That rule says you can never be charged more in interest than what you borrowed – but it doesn’t apply to these expensive consolidation loans.
Guarantor loans are deliberately targetted at people with poor credit records who are desperate.
The problem here is that once you get one, you are trapped. If your situation gets worse – perhaps your hours are cut or your benefits drop or your ex stops paying child support – you still have to make the loan repayments or the lender will go after your mum or your friend.
Many people say taking a guarantor loan is their worst ever financial decision. At the time it seemed sensible but too often it turns into a disaster you can’t escape from.
No matter how desperate your situation, you can’t go into a debt management plan or any other debt solutions without it harming your guarantor. Avoid guarantor loans and don’t put them at future risk.
If you think your mum (or whoever would be your guarantor) can really afford the loan repayment, ask them to get the loan instead. With a better credit rating, they should be able to get a nice low interest rate, not a horrible guarantor lender rate. Then you can repay that loan for them. And if your mum doesn’t have a good credit rating, you shouldn’t even be thinking of her as a guarantor!
That may sound more risky for your mum. But it isn’t. If you can’t repay a low interest loan to them you definitely can’t manage the more expensive guarantor loan.
Secured loans – dangerous – take advice before going for this
You may be able to get a secured loan even if you have a bad credit rating if you have a lot of equity in your house.
For a few people this can be a good idea, especially if it is possible to get a larger mortgage rather than an expensive secured loan.
But even if it is cheap, you are putting your house at risk. At the moment if you lose your job or split up with your partner, you can just pay less or even nothing to your credit cards and unsecured loans. But if you get a secured loan to pay off these debts, you can’t do this or you will lose your house.
And even if the secured loan looks affordable at the start, it will be a variable rate. So who knows what it could go up to in the future? Secured loans are often very long term, so interest rates could be much higher in 10 years time.
Before you decide to get a secured loan, talk to a debt adviser about what your other options are.
A DMP – many of the advantages of consolidating and bad credit welcome!
So what is your best alternative to a consolidation loan?
Look at a debt management plan (DMP). In a DMP:
- you make one affordable monthly payment to your DMP firm;
- the DMP firm divides this between your creditors – you don’t have to deal with them any more;
- your creditors are asked to freeze interest. Most of them do, even payday lenders! You can complain if one doesn’t;
- if you go to the big free DMP firms such as StepChange, you don’t get charged anything, all your money goes to pay off your debts.
This single monthly payment is a lot like a consolidation loan. And a DMP has three big advantages:
- interest is usually stopped instead of having a large amount added on;
- the monthly payments are flexible, so if things go well you can repay it faster and if they go badly, you can pay less;
- you won’t be refused because you have bad credit.
The only disadvantage is that it is bad for your credit record. But if your credit record is already poor, it probably won’t make much difference! For most people this is massively outweighed by not having to pay interest.
So give StepChange a ring on 0800 138 1111 and see if a DMP will work for you. Don’t dig yourself deeper into debt with an expensive consolidation loan.