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How Debt Consolidation Loans are Different

Why do we borrow? Cars, holidays, TVs, home improvements… the reasons might vary, but all loans mean we end up owing more. Or do they?

Debt consolidation loans stand out from the crowd. Unlike other loans, they’re designed to help people deal with the debt they already have. So they’re fundamentally different to other kinds of loan.

The principle is simple: borrowers consolidate their debts by taking out a new loan large enough to pay them all off. This can deliver three benefits in particular.

Benefits of consolidation
First of all, repaying one loan is simply easier than repaying many. Rather than juggling multiple debts – paying different creditors different amounts at different times – the borrower can just make one monthly payment. Since it’s easier to manage, the borrower is far less likely to make payments late (or not at all!), which can lead to anything from penalty charges to higher interest rates, and which always looks bad on a credit rating.

Second, there’s a good chance the new consolidation loan will come with a lower interest rate, especially if it’s used to pay off high-interest debts like credit / store cards and overdrafts.

Third, a consolidation loan gives the borrower a chance to think carefully about repayment terms. If they couldn’t keep up with repayments to their ‘old’ debts, it might make sense to pay back the consolidation loan over a longer period of time. It’ll mean they stay in debt for longer (and perhaps cost them more in the long run), but it’ll reduce their monthly payments, and sometimes that’s the most important thing.

Drawbacks of consolidation
However, there can be drawbacks to debt consolidation.

First, as mentioned above, paying a debt back more slowly means it’ll take longer gathering interest, so the total amount repaid can be higher.

Second, consolidation loans – unless handled carefully – come with a very real danger. When someone uses the loan to pay off their debts, they have to be very careful not to run up fresh debts (particularly tempting on credit / store cards and overdrafts, since they make it all too easy to borrow a few pounds here and a few there). So in general, debt consolidation is a solution that’s suitable for people who are confident in their ability to say ‘no’ to fresh credit. Anyone who isn’t confident could well be better off with a different debt solution.

Alternatives to consolidation
Either way, it’s always important to talk to a debt adviser who understands the full range of available solutions, such as debt management plans, IVAs (Individual Voluntary Arrangements), Trust Deeds (for residents of Scotland) or even bankruptcy. Each solution is unique, and its benefits and drawbacks can affect different people in very different ways – which is why it’s so important to talk to an expert first.

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