How does a debt consolidation loan work?

Are you generally managing your unsecured debts well? Do you want to make your monthly repayments easier to keep track of? Find out what a debt consolidation loan is and whether it could be the best debt solution for you…

What is a debt consolidation loan?

It’s a new loan you could take out in order to help you repay your existing unsecured debts. If you have multiple debts on things such as credit cards and overdrafts, and are repaying several lenders every month, keeping on top of your repayments every month can sometimes be confusing. A debt consolidation loan could change that and make your finances much simpler. How? By taking out a new loan, you effectively combine all you unsecured debts into just one. Therefore, you could make a single, affordable repayment every month to a single lender – so you’ll know exactly how much your debt will cost you every month.

Furthermore, you could arrange to repay your debts back over a longer period of time, which can reduce the cost of your monthly payments. But by agreeing to a longer repayment period, you’ll also be paying interest for a longer time too – which could mean you end up paying more in the long run.

However, in some cases, a debt consolidation loan could reduce the amount of interest paid on your debts. As many unsecured debts (such as some credit/store cards) can come with high interest rates, if you find a debt consolidation loan with a lower interest rate you can potentially reduce the amount you pay in the long run. Of course, this depends on how quickly you’re paying off your consolidation loan.

You should also bear in mind that a debt consolidation loan is often only suitable if you can consolidate all your unsecured debts. Finally, as with any type of loan, you should be sure you can make your repayments – and pay off the total amount – before you agree to taking it out.

What are the risks of ‘fresh debt’?

One possible downside of taking out a debt consolidation loan is that it ‘frees up’ lines of credit, such as store cards and credit cards – so you could run up new debts. If you did this, you could end up in a worse situation than when you initially consolidated your debts, as you’d have to repay any new debts on top of your consolidation loan. Of course, this needn’t necessarily be a worry. Consolidating your debts with a new loan can give you the perfect opportunity to cut up your credit cards and cancel any remaining overdrafts. It’s basically a question of how much confidence you have in your finances and your willpower – and what the best approach is for you.

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