What is debt consolidation?

One strategy to help you manage debts with multiple lenders is to consolidate them all under one form of credit. This is known as debt consolidation.

It can have several benefits for the right borrower, but there are some points to bear in mind.

To help you work out if it’s right for you, below we explain what debt consolidation is and who it might benefit.

How does debt consolidation work?

Debt consolidation is a debt repayment strategy in which you take out a single form of credit to pay off all your existing debts. So, instead of having to pay several debts under several interest rates, you’ll only repay one lender under a single borrowing cost.

For example, if you owe £500 on one credit card, £1,000 on another card and £2,000 on a loan, you could apply for a new loan of £3,500 to pay off these debts. You would then only need to focus on repaying the new loan, which could help make your debt easier to manage.

It can also work out cheaper for some individuals, especially if the interest rate on their form of debt consolidation is lower than that of their existing agreements.

Bear in mind that, if you choose to repay your debts over a longer period, this could end up being more expensive overall. Always calculate the total cost of consolidating your debt, including any early repayment charges, before applying for any form of credit.

How to consolidate debt

There are several different forms of credit you can use to consolidate debt. Popular options include unsecured and secured loans, but you could also consider a 0% balance transfer card too. Below we’ve explained some of these forms of credit in more detail.

A personal loan

You can use a personal loan to consolidate your existing debts. You may see this referred to as a debt consolidation loan, but it’s simply a standard unsecured loan with a fixed interest rate that you repay in monthly instalments.

The benefit of this is that you’ll know exactly how much your interest will cost and how much you’ll repay each month, and crucially, once the payment plan comes to an end, you’ll be debt-free.

Because these loans are unsecured, your assets, such as your home, won’t be used as collateral.

To compare some of the best loan rates on the market and see how much a loan could cost, visit our personal loans calculator.

A balance transfer card

For credit card debt only, you could consider using a balance transfer card.

This type of borrowing is designed to act like a debt consolidation loan for credit cards. It allows you to move existing credit card debts all under one account. The benefit of this is that if you find a balance transfer card with a 0% introductory rate, you won’t need to pay any interest on your debt for this period.

However, a balance transfer card doesn’t come with a fixed repayment plan, so you’ll need to have the self-discipline to keep up with your repayments each month. You should always make at least the minimum repayment each month or risk seeing your credit score damaged.

If you want to make sure you’re debt-free before the interest-free period comes to an end, you'll need to pay off more than the minimum.

To find the best 0% balance transfer cards, visit our charts.

A money transfer card

If you have overdraft debt or would like a cash lump sum to consolidate your debts, then you may want to consider a money transfer card.

While a balance transfer card will service your existing credit card debts, a money transfer card will deposit your lending into your current account. From here you can use the money to pay off your overdraft or other debts.

If you do use this form of credit, you should consider looking for a deal with a 0% introductory period and check for any fees.

A secured loan

If you’re struggling to find a personal loan, you could consider a secured loan to consolidate your debt instead. The difference between this and an unsecured loan is that a secured loan will use your assets, such as your home, as collateral if you fail to make repayments.

Secured loans typically offer a lower interest rate than a personal loan and allow you to borrow a larger sum of money. They may also be easier to get than a personal loan if your credit score is less than perfect.

But because your home is used as security, these loans also come with additional risks, namely that the lender could repossess your property if you’re unable to keep up with the repayments. It might be best to seek financial advice before taking out a secured loan to make sure it’s the right decision for your needs.

Equity release

While not a traditional form of credit, equity release can be used by those aged 55 and over to consolidate their debts.

Equity release allows you to borrow money tied up in your home. Typically, a lender will provide you with an agreed-upon sum and charge you a rate of interest. Some equity release plans require you to make interest payments, but many roll up the interest so it is repaid at the end of the plan.

Once you die or move into long-term care, your repayments will stop and the initial borrowed capital plus interest will be repaid by selling your home.

Equity release is not a decision to be taken lightly, especially if you’re considering using the money to consolidate debt. If you are exploring this option, we strongly encourage you to seek financial advice.

Does debt consolidation affect your credit score?

Generally, applying for some form of credit to consolidate debt can temporarily reduce your credit score. This is because requesting a new form of credit involves a hard credit check, which will appear on your credit history and could cause your score to drop.

Also, by paying off your lenders and closing your accounts, like a credit card or store card, you could reduce your overall credit limit. Once this happens you may find that you’re using a much higher percentage of this limit, which could have a negative effect on your credit score.

However, it’s important to stress that this initial drop can be temporary. As long as you make consistent repayments in full to the new lender, and stay on top of any other credit commitments, your credit score should begin to rise. So, in the long run, debt consolidation could have a positive impact on your credit score.

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Can I get a debt consolidation loan with bad credit?

While you won’t have access to such an array of options compared to someone with a better credit score, there are still debt consolidation options on the market for those with bad credit.

However, you’re likely to be charged a higher rate of interest than someone with a better credit history.

If you are a homeowner, you may want to start with finding the best secured loan rates, as these can be easier to obtain than personal loans for the simple reason that the lender will have your home as security. Just bear in mind that you probably wouldn’t be offered the best interest rates, and your home would be at risk if you fell behind on repayments.

Remember, if you get declined for credit, don’t keep reapplying. Making lots of credit applications in a short space of time can affect your credit score and hamper your chances of getting approved for other forms of borrowing in the future.

Instead, take time to check your credit score and see if there are any ways you can improve it. You can also check your eligibility for a loan before you formally apply to see your chances of approval without damaging your credit score.

Is debt consolidation a good idea?

Debt consolidation can be a good strategy, depending on your circumstances.

For example, it could be worth considering if:

• You have multiple debts that you’re struggling to keep track of.
• You’re eligible for a loan or other form of credit with a lower interest rate than the rate you’re paying on your existing debts.
• The total amount you would repay by consolidating your debts is less than the total amount payable on your existing debts, taking into account interest charges and any fees.

If you find the right form of debt consolidation that reduces the amount of interest you pay, it can be an affordable way to repay your debt.

Plus, because you’re only dealing with a single credit commitment, it has the added benefit of making it easier to keep track of, with only one lender and one monthly payment to worry about.

However, if it makes your debt more expensive overall, it might be worth looking at other debt repayment strategies or asking for professional advice.

To work out the true cost of your debt consolidation strategy, remember to consider one-off fees in addition to your interest rate. These are often included in balance transfer, money transfer and some loan options. Once you take these into account you might be surprised to see how much your borrowing will cost in total.