Are Loans A Good Idea – Paying off multiple debts can be difficult. Dealing with different providers is stressful and there are so many different bills to pay, it can feel like there is no way out. If you’re in this situation, debt consolidation can be a good option: it’s a way to bring all your debts together, making them easier to pay off.
In this post, we’ll explain what debt consolidation is, how it works, and whether you should consider it.
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Debt consolidation is a way of “consolidating” – bringing together – different debts into one. This means you take out a new loan and use the lump sum to pay off all your current debts. Once that’s done, you’ll pay only one lender.
There are many different types of loans you can combine, but some of the most popular are store cards, payday loans, student loans, and credit cards.
APR stands for “Annual Percentage Rate”. This includes all the costs associated with the loan and is a really useful way to compare the overall cost of different products – for more information on how they work, we’ve broken down the APRs here.
Emily has a £4,000 loan in arrears and is paying almost 50 per cent interest. (A “weighted” interest rate takes into account the relative size of each loan).
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So, in our simple example, Emily can take out a new loan of £4,000 and repay the original borrowers. And if the loan’s APR is less than 50 percent, it will also pay back less.
This is a simple overview, but there are a few more things to be aware of, which we’ll explain in the rest of the article.
A good debt consolidation loan will often mean a lower monthly payment. But that is not the whole story. There are two more things you need to remember:
Borrowing for a longer period of time may mean you pay back more, even if the interest rate is low. In another simple example, imagine you borrow £100 at 20% APR for one year. You will pay back £120 (principal £100, plus £20 interest).
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If instead you borrow £100 at 3% APR for 10 years, you will pay back £130 (principal £100 plus £30 interest). In this example, you pay back more in total even though the interest rate is much lower.
This is an extreme example and low interest rates are still a good thing. And the borrower may also find that lower monthly repayments over a longer period of time are better suited to his or her situation. But make sure you weigh the pros and cons before committing to a longer loan.
An online loan calculator should help you with the maths here, but any good loan provider will help you by telling you the total repayable amount.
When taking out a debt consolidation loan, you need to be sure that you can afford the monthly repayments. Defaulting on any type of loan is a sure way to a bad credit score.
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When deciding whether to give you a loan, lenders should do an affordability check, as well as check your credit rating.
However, you still need to measure your affordability, especially if you are expecting big life changes. Are you having a baby soon? Are you thinking of moving house? Could your job be in jeopardy? If so, you should factor these into your decision and it is your duty to apply for a loan.
Credit card debt can be expensive. As a result, many people use personal loans – which can often have lower interest rates – to pay off credit card balances, lowering monthly repayments in the process. Our guide to borrowing to pay off credit card debt has the pros and cons.
In most cases, credit cards start out with a low interest rate, but the rate will usually increase as you borrow for a longer period of time, especially if you don’t make the minimum payment.
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Another option is to consolidate an existing loan with a personal loan. The advantage here is that you can tailor a product to your situation: modern loan providers allow you to choose exactly how much you want to borrow and for how long.
So, you can set up a loan that suits you, and like a balance transfer using a credit card, the interest rate you pay is usually locked in – so you don’t have to worry about moving money around again in a few months. the line
There are two types of personal loans: secured and unsecured. A secured loan is one where you borrow against the value of an asset – often a home or car. If you fail to make monthly repayments, your property may be at risk, so it’s something to think about carefully. However, the advantage is that if you use a secured loan, you can borrow at a higher or lower rate.
As a general rule, if you’re borrowing less than £25,000 and have a good credit history, you’ll be able to get an unsecured loan.
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However, if you are borrowing more than £25,000 or have a poor credit history, you may want to consider a secured loan.
The above is just an indication – which option is right for you will depend on your individual circumstances, so always shop around. Taking a secured loan to pay off an unsecured loan is generally considered bad.
With this option, you transfer the debts you have to a balance transfer credit card with a lower APR. In some cases you can even find a credit card with a zero APR to start with.
However, these introductory offers only last for a certain period of time, so you need to check what the APR will be after the offer ends. You also need to make minimum monthly repayments, otherwise costs add up quickly – if so, you could end up paying more monthly than you started with.
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Another thing to keep in mind is that balance transfer credit cards often have fees, which can be as high as 5%. We’ll take another look at detailed charges later, but of course, it’s usually best to avoid them. Fees are usually added to the loan balance, rather than paid up front.
In general, borrowers with good credit scores are likely to be offered deals with long interest-free periods and low or zero fees, while borrowers with poor credit history will get shorter interest-free periods and usually have to pay fees.
If you’re really struggling with your existing debts, and don’t believe you’ll be able to pay them off, you may be eligible for debt relief. This is a last resort and should not be taken lightly. This will have a permanent effect on your credit score, but it can be helpful if you have serious financial problems. This means that the lender will put you on a debt management plan (DMP) and generally lower your monthly repayments, so that you pay off the loan over a longer period of time.
There are real consequences for doing so, and it’s highly likely that you’ll struggle to get credit in the future. It will definitely take a lot of time to be able to improve your credit history.
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If you are struggling with debt, a good place to start is StepChange, a UK debt charity, which has resources and free advice to help.
Some providers charge different fees, which can add up. They have different names and serve different purposes – if you have a mortgage, for example, you’ll probably pay an arrangement fee and maybe even a broker fee.
Some lenders charge you a fee for early repayment. If your current lender charges early repayment fees, you need to factor this cost in when figuring out whether a debt consolidation loan makes sense.
It is charged up front by the lender, meaning you have to pay before you get the loan. The FCA has reported growing concerns about scam loan fees – you should always be very careful if you’re asked to pay upfront for a loan, and if you’re worried, you can see their guide here.
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This only applies to balance transfer credit cards: typically, the fee is added to your payment, rather than being charged up front. So, if you transfer a £1,000 loan to a credit card with a 3% fee, you’ll have £1,030 left to repay.
You can also find companies that want to charge you a fee to manage the debt consolidation process or give you advice. In general, debt consolidation is something you can arrange yourself, so you should avoid paying
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