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Debt consolidation works to simplify your finances by combining your outstanding balances together into one more manageable monthly payment.
There are lots of options on how to consolidate your debts, these include, a personal loan, a credit card, debt management plans, or repaying your debts using equity built up in your home.
Here is an in-depth look at how debt consolidation works, its benefits, and things to consider before opting for this approach.
What is Debt Consolidation?
Debt consolidation involves taking out a new loan to pay off multiple existing debts. The idea is to combine various obligations—such as credit card balances, personal loans, and other liabilities—into one loan, ideally with a lower interest rate. This can make your debt easier to manage, as you’ll only have one monthly payment to keep track of instead of several.
The new loan can either be on an unsecured basis, such as a personal loan, or a secured basis which is where you use the equity in your home to repay your debts.
How Does Debt Consolidation Work?
A good place to start when considering debt consolidation is by making a comprehensive list of your current debts. Include details such as the total amount owed, the interest rate for each debt, and the minimum monthly payments.
Next, it is always a good idea to know what your current credit score is and see if it has been impacted by your current debt level.
You are more likely to qualify for a debt consolidation loan if you have a good income that is reliable and steady, can prove that you have the spare income to repay a loan, and a good credit score.
Debt Consolidation Method Choice
There are various methods and products that you can use to consolidate your debts, these are:
A personal loan
Personal loans can be a good way to consolidate debts if you can qualify for enough borrowing at a good rate. With a personal loan, the borrowing will be repaid at the end of the term if all payments are met.
Balance Transfer Credit Card
This option involves transferring all your existing credit card debt to a new credit card with a lower interest rate, often an introductory 0% APR for a set period. Often, these periods can be up to 2/3 years nowadays giving you plenty of time to repay the debts with zero interest. However, you’ll need a lot of self-discipline not to use the card for new purchases.
Homeowner loans
If you own a home, you can borrow against your home’s equity to consolidate debts, these are often called secured loan mortgages. These loans often have lower interest rates but put your home at risk if you default. It is always a good idea to seek independent mortgage advice to ensure you understand the risks and features associated with securing debts against your home. Other options with regards to using the equity in your home to repay debts include a debt consolidation remortgage or a further advance mortgage with your existing lender.
Benefits of Debt Consolidation
Here is a summary of the main benefits of consolidating your debts:
- Simplified Payments: Managing one payment is easier than juggling multiple due dates and amounts.
- Lower Interest Rates: Consolidation loans or balance transfer credit cards can offer lower interest rates than what you’re currently paying, saving you money over time.
- Fixed Repayment Schedule: With a consolidation loan, you’ll have a clear timeline for when your debt will be paid off, helping you budget more effectively.
- Improved Credit Score: Successfully managing and paying off a consolidation loan can improve your credit score over time.
Disadvantages of Debt consolidation
- Upfront Costs: Some consolidation loans and balance transfer credit cards come with fees, such as origination fees or balance transfer fees. Be sure to factor these into your decision.
- Risk of Homeowner Loans: If you use a home equity loan or remortgage for debt consolidation, your home is collateral. If you default, you risk losing your home. You will be taking currently unsecured debts and then securing them against your home which is a very high-risk strategy.
- Discipline Required: Consolidation is not a cure-all. You must commit to not incurring new debt and to making regular payments on your consolidation loan.
- Long-Term Costs: Lower monthly payments often mean a longer loan term. While this can provide immediate relief, you may end up paying more in interest over the life of the loan. This can result in you being worse off financially than you had been prior to consolidating your debts.
When to Consider Debt Consolidation
Debt consolidation might be a good option if:
- You have multiple debts with high-interest rates.
- You are struggling to keep track of various payments.
- Your credit score is good enough to qualify for a lower interest rate.
- You have a steady income and can commit to a repayment plan.
Mortgage Advice
Debt consolidation can be a useful tool for managing and reducing debt, offering the potential for lower interest rates and simplified payments. However, it’s important to carefully evaluate your financial situation and the terms of the consolidation loan or credit card. By doing so, you can make an informed decision that helps you achieve financial stability and peace of mind.
If you’re considering debt consolidation, consult with a mortgage advisor or credit counsellor to explore your options and create a plan tailored to your unique circ*mstances. Remember, the goal is not just to consolidate debt but to become debt-free.
In relation to taking unsecured debts, releasing equity, and then securing this new money against your home is high risk and should not be undertaken without seeking professional advice. If you are unable to pay your monthly payment, your home could be repossessed, and you could become homeless.
You should carefully evaluate the implications before proceeding with a debt consolidation mortgage application, as it will increase the total mortgage balance secured against your property. Failing to keep up with mortgage payments could result in your home being repossessed by the lender.
