What is debt consolidation?

Know what questions to consider before you decide to consolidate your debts.

Here's what you'll find out:

➜ How debt consolidation works

➜ When debt consolidation can cost you more

➜ Questions to ask to before consolidating debts

If you have a number of debts, you may have the option to consolidate them into one loan. While it won’t reduce the amount you owe, it can make managing your repayments easier.

This is because you’ll have one monthly repayment to make and a clear schedule for when you’ll have repaid the debt. This can give you an end in sight for when you'll be debt free.

But debt consolidation can also cost money in increased interest and fees. Even if your interest rate is lower, the term of the loan may mean you end up paying more.

How debt consolidation loans work

A debt consolidation loan is a new loan you take out to merge multiple debts.

This can include items like:

  • Credit cards
  • Store cards
  • Personal loans
  • Payday loans.

It can be difficult to manage multiple repayments, so bringing everything together can really simplify things. It can also remove the temptation to keep spending if you’re then able to close any credit cards and store cards that you’re currently using.

If you’re approved for a loan, the money won’t necessarily go straight to your debts. It will go into your bank account and you’ll have to make the repayments and close the accounts.

Different loan providers will have different conditions, but it’s likely you’ll then make one monthly repayment to pay off the loan and bring down the balance over time.

For some people, having one repayment and one interest rate helps them to feel more in control of their money. And if it’s cheaper to consolidate your debts than keep making your repayments, a debt consolidation loan may work for you.

How debt consolidation loans can cost you money

In some instances, the convenience of a debt consolidation loan can be outweighed by the cost. There are a couple of ways that a debt consolidation loan can end up costing you money in the long run, even if your monthly repayments will be reduced.

These are:

  • If there are fees for repaying any of your current debts early
  • If the interest rate of the debt consolidation loan is higher than the interest rates you’re currently being charged
  • If the term of the debt consolidation loan means you’ll be repaying the debt for a longer amount of time.

Before making any decisions, it’s really important to check the above so you can assess what’s going to be best for you.

Is a debt consolidation loan is right for you?

1. See if there are any charges

Start by taking note of any fees you may be charged for making repayments early – typically called early repayment charges. These fees won’t be charged on credit or store cards but can be part of some personal loan agreements.

2. See what interest rate you could get

Most banks will have calculators on their websites that will give you an indication of what your interest rate would be and how much you would pay in interest over the course of the loan. Even though this probably won’t be the interest rate you’re charged, it’s important to use these calculators as an application for a loan may impact your credit score.

3. Compare interest rates

How does the potential interest rate and amount of interest you’ll be charged stack up against the current interest rates you’re repaying? There are a couple of things to keep in mind here:

  • A lower interest rate over a longer period of time may still end up costing you more
  • You can repay your credit and store cards at any time, so you’ll have to estimate how much interest you’re likely to be charged before you’ve paid them off in full – again, there are calculators online that can help you with this.

4. Make a considered decision

Based on what you’ve worked out above, does it seem like a debt consolidation loan is a good idea? The answer will depend on your personal circumstances.

If you need help, you can speak to your bank and they may be able to provide some advice. There are also debt relief charities that should be able to assist.

What next?

See some techniques for repaying debt that can help you clear your debts faster.

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