Debt consolidation loans

What is a debt consolidation loan?

A debt consolidation loan combines all your existing debts in one place so that you only make one payment each month to a single lender.

If you’re struggling to repay multiple debts, a debt consolidation loan could make your repayments more manageable.

There are two main types of debt consolidation loan – secured loans and unsecured loans (often called personal loans).

Secured loans

Secured debt consolidation loans tie your debt to an asset you own. Many secured debt consolidation loans work like a second mortgage and are secured against your home. To use this kind of debt management you would need to have equity in your home, meaning your house was worth more than your outstanding mortgage.

You could also secure your loan against other valuable items but you would need to own something that was worth more than the total you wanted to borrow. A secured debt consolidation loan would only be for a fraction of the value of your asset.

If you were unable to repay your loan, the lender could sell your prize asset to pay off the debt. They might sell it at less than it was worth, take what you owe and give you back barely any of your property’s original value.

That doesn’t sound fair but could happen. It’s why a personal loan that does not put your assets at risk might be a better choice for your own debt management plan.

Personal loans

Personal loans allow you to borrow a lump sum that you pay off, with interest, in a fixed number of instalments but don’t require you to use an asset as security. They may be less risky for you as the borrower so could be an attractive debt management route.

The lender will charge interest rates based on your financial circumstances and past record of borrowing. They get this debt repayment information from your credit score. Someone with a good credit score might pay single-digit interest rates while someone with a poor credit score could pay many times that rate.

How do debt consolidation loans work?

Debt consolidation loans enable you to use the amount borrowed to repay your existing debts. You then start paying your new lender instead.

Existing debts could include:

• Credit cards
• Overdrafts
• Personal loans
• Store cards.

Consolidating your debts won’t reduce the total amount you need to repay, but it can make it easier to stay on top of your debt repayments. What’s more, if your new loan has a lower interest rate, you could reduce the overall amount of interest you pay.

For example, let’s say you had the following debts to repay:

• £2,000 on a credit card charging 26% APR representative
• A £1,000 overdraft at a rate of 39.95% effective annual rate (EAR)
• A personal loan of £5,000 at a rate of 15% APR representative
• £2,000 of store card debt charging 30% APR representative

Your total debt is £10,000. If you took out a debt consolidation loan of £10,000 charging a rate of 8% APR representative, the table below, taken from an online loan calculator, shows how much you would repay over a term of three and five years.

Eligibility criteria

Always check the eligibility criteria before applying for a debt consolidation loan. Most lenders will require you to be at least 18 years old and a UK resident. But your eligibility might also depend on:

• Your income and employment status: Some lenders will have minimum income requirements and you might need to be in full-time employment. This suggests stability and that you’re more likely to be able to repay your loan.
• Your credit score: Lenders will look at your credit record to assess your credit risk, including whether you have a history of missed payments. If you have borrowed responsibly in the past and have a good credit score, you’re more likely to be accepted for the loan you want and secure a competitive interest rate.

Many lenders have eligibility checkers on their websites. You can use these to find out how likely you are to be accepted for a particular loan, as well as the interest rate you could secure. Eligibility checkers only use a soft credit check – the check won’t have any impact on your credit score.

Required documents

Make sure you have the required documents to hand before you start your application. These might include:

• Proof of identity, such as a passport or driving licence
• Proof of address, such as a recent utility bill or mortgage statement (dated in the past three months)
• Proof of income, such as bank statements or payslips.

You’ll also need to provide your address history for the past three years and your bank account details.

Application process

The steps below outline how the application process works:

1. Calculate your total amount of debt: You’ll need to work out exactly how much you need to borrow to be able to repay your existing debts.
2. Compare debt consolidation loans: It’s best to compare loans from several lenders. Check the annual percentage rate (APR) and whether there are any fees for arranging the loan or for early repayment. Also ensure the lender is approved by the Financial Conduct Authority (FCA).
3. Use an eligibility checker: This will show you how likely you are to be accepted for a particular loan without harming your credit score.
4. Make your application: Once you’ve found the loan you want to apply for, make your application in full. This will involve a hard credit check and will show up on your credit file.
5. Pay off your debts: If approved for the loan, the funds will be transferred to your bank account and you can pay off your existing debts.
6. Pay off your new loan: You’ll then start making monthly repayments to your new lender. Setting up a direct debit can help you to remember to make your repayments on time, but make sure you have enough money in your account to meet your monthly commitment.

Can you consolidate debts with bad credit?

You can consolidate debts even if you have a bad credit score. However, you might have fewer lenders to choose from and may not be able to borrow as much as you’d hoped.

Borrowers (or debtors) with poor credit scores might find it easier to get accepted for a secured debt consolidation loan than an unsecured one. That’s because the loan is backed by an asset, which reduces the risk for the lender. But you should always consider secured loans with care.

Any missed repayments on any loan can negatively affect your credit record and your lender could start debt collection proceedings or take court action against you.

Speak to your lender as soon as possible if there’s any danger of missing loan repayments. Your lender should be reasonable and help you come up with a more manageable repayment plan.

Potential benefits of consolidating your debts

There are several benefits of consolidating your debts. These include:

Simplified payment process

Instead of making multiple payments to different lenders each month, you’ll only make a single payment each month to one lender. This can make it easier to manage and keep track of your payments.

Lower monthly repayments

If you spread your debt over a longer period, your monthly repayments will be reduced. This could make it more affordable. However, repaying a loan over a longer time will generally mean paying more in interest. Use a loan calculator to see the difference for various APRs. For example, if you borrowed £3,000 at a rate of 15%, the table below highlights how much you would pay in interest over terms of three and five years.

Improvement in credit score

Provided you make all your repayments on time, you should start to see an improvement in your credit score.

This could happen within a month or two, but it may take up to six or 12 months.

If you notice your credit score has improved after a year or so, check whether it is worth you taking out a new loan at a lower APR to repay what is left of your initial loan. For some people this might work out cheaper.

Better interest rates

Your debt consolidation loan might charge a lower rate of interest compared with the rates you’re currently paying on your existing debts. This means you could save money in the long run.

Is a debt consolidation loan the right option?

To help you decide whether a debt consolidation loan is right for you, consider the following:

Assessing your financial situation

Think about whether you will be able to afford your new monthly repayments. If taking out a debt consolidation loan results in you paying a lower rate of interest over a longer term, it could be more affordable.

But if applying for a larger loan means it’s more difficult to repay, you might want to look at alternative options instead. Debt consolidation loans won’t always be the right choice if you’re near to paying off your existing debts or if you can’t get a large enough loan to cover your debts.

Comparing interest rates and terms

When comparing interest rates and terms you ideally want to pick the loan with the lowest APR you’ll qualify for. But you’ll also need to consider how long you’ll have to repay your new loan. A longer repayment period means lower monthly repayments, but you’ll also pay more interest overall. If you can afford to opt for a shorter term, you could pay off the loan faster and save interest.

It’s worth using a loan calculator to help you work out what your monthly repayments would be, looking at different interest rates and terms.

Understanding the impact on your credit

Before applying for a debt consolidation loan, you need to be sure you can keep up with your monthly repayments and pay it off in time. Failing to repay the loan can damage your credit score and could result in you losing your home (if it’s a secured loan) or court action (if it’s an unsecured loan).

Taking out a loan to cover debt repayments can be risky, so it’s crucial to work out exactly how much you can afford to repay each month.

If you believe your lender has provided you with an unaffordable loan, maybe because its affordability checks weren’t sufficient, you can complain to the Financial Ombudsman Service (FOS). But they will likely ask you to raise your concern with the lender first. If you have not been able to find a resolution within 8 weeks the Financial Ombudsmen will take a look at you complaint.

Managing your finances after debt consolidation

Once you’ve consolidated your debts, keep your finances on track by following the steps below:

Create a budget

Go through your bank statements and make a list of how much money you have coming into your account each month and how much you spend on household bills and other expenses. This should give you a clear picture of where your money is going and ensure you don’t have more going out of your account than you have coming in.

As you go through your statements, you might also spot places where you can make cutbacks – perhaps there’s a subscription you no longer need or maybe you could switch broadband providers and save money.

Money Helper offers a free online budget planner that can help you take control of your household debt and spending.

Avoid additional borrowing

To keep your finances on track, it’s best to avoid additional borrowing. Your budget should help you better manage your money and reduce the need to rely on borrowing to see you through.

Build an emergency fund

If you have any money left over at the end of each month, you could use these funds to build up an emergency savings pot. That way you’ll have cash to fall back on if you need to pay for an unexpected bill or other expense.

Setting up a monthly standing order to automatically transfer a sum from your bank account to your savings account could help you remember to save. Alternatively, you could move money across manually whenever you can afford to.

Alternatives to debt consolidation loans

Debt consolidation loans are not the only debt solution. Make your own debt management plan that fits your circumstances. You could consider the following alternatives:

Balance transfer credit cards

If you have multiple credit card debts to pay off, you might be able to move these debts to a balance transfer credit card. If you get accepted for a card that charges a lower interest rate, or even no interest for several months, you could save money on interest payments and pay off your debts faster.

However, you’ll need to keep the following in mind:

• You’ll often pay a fee of around 2% to 4% on the balance you’re transferring.
• If your credit card has a 0% offer, it’s best to try and clear your balance before the 0% deal ends and interest kicks in. Otherwise, you might need to think about moving your debts to another 0% balance transfer card (with another fee).

Money transfer credit cards

Another option is to use a 0% money transfer credit card. These credit cards let you move a portion of your card’s credit limit (usually around 90% to 95%) into your bank account. You can then use this money to pay off existing overdraft or loan debts, for example. Monthly repayments are made to your new credit card provider.

Again, there will often be a transfer fee to pay (around 4%), and it’s best to clear your balance before the 0% deal ends and interest kicks in.

Negotiating directly with your lenders

If you’re worried about the amount of debt you’ve accrued and how you’ll repay it, it’s worth speaking to your lenders. They should work with you to help you come up with a more manageable solution, perhaps by lowering your monthly repayments.

Speaking to debt charities

It can also be wise to speak to a debt charity such as Citizens Advice or StepChange. These charities offer free advice and can help you come up with a solution that works for you and your lenders. They can also assess whether certain insolvency solutions might be appropriate.

Government figures show that the number of individual insolvencies registered in 2023 in England and Wales was 13% lower than the previous year, at 103,454.

IVA

An individual voluntary arrangement (IVA) is a formal and legally binding agreement with your creditors to pay all or some of your debts over a period of time. IVAs are available in England, Wales and Northern Ireland.

An IVA must be setup by a qualified insolvency practitioner who will normally charge fees for setting up the arrangement. Once setup, you’ll make regular payments to the insolvency practitioner. They will keep some of the payment to cover their fees and split the remainder between your creditors.

While you have an IVA, your creditors should no longer chase you for payments or charge you interest.

Trust deed

A protected trust deed is only available in Scotland. It’s a formal arrangement with your creditors to pay a regular amount of money towards your debts. At the end of a set period, normally four years, the remainder of your debts will be written off.

DRO

A debt relief order (DRO) can help you to write off or cancel your debts. DROs are only available in England, Wales and Northern Ireland. A DRO typically lasts 12 months and if you’re approved, you won’t make any debt repayments during that time. Once the 12 months are up, the debt is cancelled.

Bankruptcy

Bankruptcy is a legal process that writes off your debts, typically after 12 months.

Bankruptcy in the United Kingdom can work slightly differently depending on where you live. In England and Wales, you can apply for bankruptcy through the government website if you can’t pay your debts. It costs £680.

In Northern Ireland, bankruptcies are made through the court. This costs around £683, including court fees and solicitor fees.

In Scotland, bankruptcies are made through the Scottish insolvency service called Accountant in Bankruptcy (AIB). This costs up to £150.

Your creditors can also apply for a bankruptcy order if you owe them at least £5,000.

Any form of insolvency is recorded on your credit file for a period of 6 years and can make it harder for you to get credit again in the future. It’s best to seek financial advice if you’re considering any of the above options.

Common questions about debt consolidation loans

Is debt consolidation a good way to get out of debt?

A debt consolidation loan can be a good way to get out of debt, but you’ll need to consider your personal and financial situation first to make sure it’s right for you. A debt consolidation loan requires you to borrow more money, so you’ll need to be confident you’ll be able to meet your monthly repayments.

What is the maximum I could borrow?

The maximum you can borrow will depend on the lender, as well as factors such as your credit score and your income. You ideally want to borrow enough to cover all your existing debts.

Can I get a debt consolidation loan if I have a poor credit score?

It is possible to get a debt consolidation loan for bad credit, but you might have fewer lenders to choose from. You might find it easier to get accepted for a secured loan as they are less risky for the lender.

Can I pay off my debt consolidation loan early?

You can often pay back a debt consolidation loan early, but you might have to pay an early repayment fee. This is often the equivalent of one to two months’ interest. Check your lender’s terms and conditions carefully.

Will debt consolidation affect my mortgage?

An unsecured debt consolidation loan will not affect your mortgage but if you take out a secured loan against your property, that new lender will take a second charge against your property. This will act as a second mortgage, while your first mortgage remains in place. This means you’ll have two mortgages on the same property.

Summary: Debt consolidation loans

Debt consolidation loans help some people take control of their borrowing and could save you money if you find a loan with a cheaper interest rate. However, they won’t be the right option for everyone and you should seek financial advice if you’re unsure.