How does debt consolidation work?

How does debt consolidation work?
September 22, 2016 admin
How does debt consolidation work

Debt consolidation can help you to reduce your monthly repayments when you already have many debts to manage.

But how does debt consolidation work? and is debt consolidation the right choice for you?

What is debt consolidation?

‘Consolidation’ gets defined in the Merriam-Webster dictionary as the ‘process of uniting’.

In the world of debt management, this means bringing together many debts. Also, streamlining them into one manageable, monthly payment.

When you merge your debts, you will normally take out a large loan to pay off some, or all, of your existing personal debts.

If you owe £3,000 on a credit card, have a £2,000 personal loan and have a further £300 on a store card or two, you could choose to borrow £5,300 and settle all three debts in full.

The benefits of debt consolidation

Reduced monthly repayments

Many people discover consolidating their debts enables them to reduce their total monthly repayments

As you are only repaying one debt, you may enjoy a smaller monthly instalment amount.

Easier debt management

You might find it difficult to keep track of how much you owe and juggling many repayment dates. Yet, you may find your money easier to manage once your debts get consolidated.

You will only need to keep track of one single loan, which means that only one repayment will need to get made each month.

You will also avoid any issues surrounding debt prioritising. Where a lean financial month might have left you wondering which repayment to make and which payments to default on.

Ease of communication

If you do find yourself having one or two difficult months with less money available than you expected, then it is easier to work with just one lender.

You may be able to come to an agreement such as a payment break, or temporarily reduced repayments.

If you have loans with many creditors, communication becomes more difficult.

You might find yourself negotiating with many creditors at once, trying to get them all to agree to a solution that helps you out of your difficulty.

Unfortunately, most creditors will always see themselves as the priority.

The downsides

Extended time in debt

When you move all your debt to one location, you are starting with a brand new loan.

Often, you could be making loan repayments over a longer period than the existing group of smaller loans.

Although the likelihood is your repayments will be smaller and more manageable, the total time of being in debt could extend.

No repayment drops

If you had many debts and were paying them off alongside one another, then each individual loan/ debt would likely end at different times.

As each individual debt ended, the amount that you would be spending on debt repayment would decrease accordingly.

Once a debt has been fully paid off, many people choose to invest this extra money, by repaying the remaining loans even sooner.

If you found yourself with an extra £30 per month to spare, you could increase your repayments elsewhere and get out of debt more quickly.

If you merge your debts, you will be committing to equal repayments over the full course of the new loan term.

Risk and temptation

Frequently, people that go through the process of debt consolidation find themselves in much more debt than ever before.

If you are likely to mismanage your credit, then this is something to factor into your decision.

When you merge your debts, it is important to close down all other lines of credit.

This means that you should fully repay your credit cards and store cards, cut them up and close the accounts.

Without discipline you may find yourself getting a debt consolidation loan. The reasoning is to clear their various debt obligations only to begin making purchases on their cards again.

Does debt consolidation increase or decrease debt?

Whether debt consolidation will save you money or cost you more, will depend on your individual circumstances.

Often, if someone is significantly extending the amount of time that they are in debt then they will often end up paying more.

Even lower interest rates, over a longer period of time, can result in significant interest repayments.

In reality, if you are at the point of applying for debt consolidation your credit file will likely already get affected.

You could appear to be high-risk if loan providers can see you have debts with many borrowers and are asking to borrow again to keep up with them.

As a result, the credit offered to you may come with a higher interest rate.

Whether you can save money by consolidating your debts depends on what debts you currently have.

Are you struggling with overdrafts, credit cards and other debt you are servicing without reducing. Then you could find that you are currently paying a considerable sum of money to each with almost no impact on the actual loan.

In cases where people are servicing debts but not repaying them or get caught in a debt spiral where they are paying high charges and fees each month. Then debt consolidation can often help pull them from this situation.

Consolidating your debts could give you the breathing space that you need.

Important things to consider when consolidating debts

Fees and charges

Some credit providers will charge an early repayment fee.

This means that if you are repaying your loan in full before the original end of the loan term, you may get charged extra for doing so.

When you are applying for a debt consolidation loan, make sure you find out the final settlement amounts for any existing credit.

If there are early repayment fees, you will need to factor these into your calculations and add them to the amount that you are looking to borrow.

Some debt consolidation loans also come with early repayment penalties, so check the terms of the loan that you are applying for as well.


The appeal of lower monthly repayments could lure you in, even if you cannot afford them.

If you are struggling with your current repayments but want to decrease them through debt consolidation, you might be paying more than you can handle.

Simply decreasing your monthly payments may not be enough to gain control of your debt situation.

Before you go through with consolidation, make a clear and detailed budget. Find out exactly how much you can afford to pay.

Consider any changes in circumstance that may reduce your disposable income further. Including, potential redundancies at work or a new baby on the way.

If you have a variable income, perhaps because you are a seasonal worker, self-employed or on temporary contracts, committing to a large loan may not be a suitable way of managing your debts.

Accepting a loan offer will not make anything better if your repayments are still too high.

Total cost of debt

Lower monthly repayments are universally appealing. Everyone wants to be paying out less than they currently are.

Is debt consolidation absolutely essential?

You may be considering consolidating because you like the idea of paying less each month and having more disposable income. Perhaps take a more long-term view.

How much will it cost to clear your debts in your current situation?

How much would you end up paying for your debt consolidation loan?

It is important to check whether the lower monthly payments are really worth any increase to your debt obligations.

Potential improving circumstances

When thinking about whether your financial circumstances might deteriorate, leaving you struggling to repay your debts. It is also worth evaluating whether they are likely to improve.

You may be considering a debt consolidation loan in a time of personal financial crisis. When you are feeling particularly overwhelmed by your debt.

If you are due a pay review at work, or may have more disposable income in the coming months, then you might decide instead to wait and see what happens.

You may have only just been managing to make small payments on your credit cards and you expect your future to be more of the same. Then this may be a sign it is time to take action.

If you are only struggling temporarily, you may not want to commit to any action that will affect you for years to come.

Risks of secured debt consolidation loans

In a desperate situation, you may get tempted to try for whatever loan you can get.

You might think about applying for a secured loan when you get worried about your debt levels.

These are often less expensive, because they represent a much lower risk for a lender.

Secured loans are set against your property – usually a house or car. If you cannot meet your repayment commitments, lenders can get their money back by selling your assets.

The recommendation is that you are careful not to agree to a secured debt consolidation loan.

A change in circumstances or poor future debt management could mean that you lose your home.

Unsecured loans for debt consolidation are safer, though still risky if you cannot make your repayments.

Alternatives to debt consolidation

The main reasons for people to apply for debt consolidation are:

  • to decrease the amount that they are paying each month
  • to keep all their debts in one place so that they are easier to manage

Debt Management Plans, IVAs and bankruptcy

A Debt Management Plan (DMP) could be a suitable alternative, helping you to manage your debt more effectively.

Most people use a debt management company, or charity, for support with running a DMP.

When you set up a debt management plan, you can reduce the amount that you pay to each creditor so that it is at a manageable level.

If you have been struggling to find enough money to service your debts, this can help you to keep your head above water.

Your chosen debt management company can take a single payment from you, splitting it fairly between your creditors.

This means that you do not need to make many payments, or manage varied repayment dates.

Though they do not have to, many creditors will freeze interest and charges for customers on a Debt Management Plan.

There are other options. Including Individual Voluntary Arrangements (IVAs) and bankruptcy. These may be better solutions, depending on your current debt situation.

0% balance transfer credit cards

You may be able to make use of 0% balance transfer credit cards. This should only be an option if you can transfer all your debts.

If you leave some debts elsewhere, you will still have to make many payments each month and may struggle to keep up with what you owe.

You should also feel sure that you can repay your debts before the interest-free period runs out. Or, that you can at least move the remaining debt elsewhere now.

If you move all your debt to a 0% interest credit card and do not pay it off, you may find that the debt becomes unmanageable once the interest gets applied.

Warning – most balance transfers will incur a ‘balance transfer fee’ which may be more than the interest you are currently paying. As always, do your homework and look at all associated costs.

Before applying for a debt consolidation loan

Before you apply for any form of credit, take time to carefully look over your credit file.

Ensure that it is 100% accurate and that you have done everything you can to boost your credit rating. Such as making sure that you are on the electoral roll.

Rejected loan applications may leave you with a lower credit rating. As well as nothing to show for and could affect future credit applications.

So you should work hard to minimise any potential risks of false information before you apply for a debt consolidation loan.