Debt Consolidation Explained
Debt consolidation is one of the most popular reasons for taking out a secured loan or remortgage, but what is it and is consolidation something that could work for you?
How Does Consolidation Work?
The basic idea behind debt consolidation is that you are combining all your various debts into one, and in the process lowering the amount you have to pay in monthly repayments. You can do this by taking out a single loan or remortgage which you then use to pay off your other more expensive debts.
Most of your debts, apart from your mortgage, will be probably be unsecured: this means that they are not supported by any assets which you can use as a guarantee that the debt will be repaid. Examples of unsecured debt include credit cards, store cards, some personal loans, catalogue accounts etc.
As you are not offering any security for the debt, the loan is more risky for the lender and the interest you'll have to pay will usually be higher. If you combine all your unsecured debt into a secured loan or remortgage, or even an unsecured loan at a lower rate, your monthly repayments should be lower.
Benefits
- An effective debt consolidation program will mean your monthly repayments will be lower, as you're borrowing at a lower rate to repay higher-rate debt
- Your financial situation will be simpler - just one monthly repayment rather than many, which is less stressful if you're struggling
- Less chance of missing payments, as you have less of them, which helps to protect your credit rating
- If you get a loan with deferred repayments, also known as a payment holiday, you'll get some breathing space to put your finances back in order
Drawbacks
- The repayment period of your new loan will often mean you're in debt for longer, and are therefore paying more interest in total overall. You should weigh up whether tightening your belt and paying more each month for a shorter time (if possible) is a better idea
- Moving unsecured debt to a secured loan will mean your home is at risk should you struggle to make the repayments
- Once you've consolidated, it can be tempting to then run up yet more unsecured debt leaving you in a worse position than ever. Make sure you cancel credit cards etc once you've cleared the debt to remove this temptation
Is Debt Consolidation for You?
Only you can make that choice. You will probably end up with lower repayments, but at the cost of a new long-term debt. Consolidation is definitely worth considering if you're genuinely going to save money by doing so, or if you're struggling financially and really need to reduce monthly payments, but it's always preferable to pay off existing debts entirely rather than prolonging debt by refinancing if possible.
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