How Does A Debt Consolidation Loan Work?

Written by David Soffer on July 14, 2022

Updated July 14, 2022

A debt consolidation loan is designed to help those with numerous outstanding debts bring all or many of their debts together into one debt or loan arrangement, to then be paid off in affordable monthly instalments.

Debt consolidation loans can help simplify your debts by streamlining them into one monthly payment, each month, at a convenient and more logical time of the month, rather than potentially having numerous debts whose repayments need to be made throughout the month, affecting your budgeting and cashflow. 

Loans for debt consolidation can be a good way to get you back on track financially and take control of your debts, once and for all. They are also a good way to show any existing creditors that a borrower is taking control of their debts and finances in a responsible manner.

What Is a Debt Consolidation Loan?

A debt consolidation loan is a way for people to refinance their existing debt; often a combination of loans and other financial arrangements. 

Borrowers simply apply for a debt consolidation loan for the full amount that they owe across multiple existing debts. Once approved, they can use the funds in order to pay off their debt balances. They can then move any remaining debt to one loan and streamline loan repayments which they will pay off over time.

For example, a person with numerous debts may owe £2,000 on their credit cards, £500 on car finance and a further £500 due to be repaid on other loans all totalling £3,000. However, with interest on any money owed, the borrower may owe hundreds of pounds more. 

Thus, debt consolidation loans allow the borrower to borrow the full amount, totalling all debt obligations. The borrower can then pay off all debts in one go and then work with the debt consolidation lenders to repay a single loan in a more manageable way over an agreed period of time.

What Are the Features of Debt Consolidation Loans In the UK?

Debt consolidation loans in the UK may be secured or unsecured, depending on numerous factors such as how much the borrower owes and how many debts are outstanding. Furthermore, different borrowers in the UK will be regulated by the FCA to provide different natures of debt consolidation loans, which should always be checked before taking the loan in question.

When choosing a debt consolidation loan, you will need to consider different features:

  • Type of Loan – There are different types of loans that you may want to consider including personal loans, credit cards and home equity loans
  • Terms of the Loan – This looks at the amount of the loan, interest rate and duration of the loan. You can use these terms to compare and contrast different loans in order to determine the best one to suit your needs
  • Secured or Unsecured – Secured loans means that you put down collateral which means that should you miss a payment, you could have your belongings repossessed. Unsecured loans do not require collateral but usually have higher interest rates and fees so can be more expensive in the long-run

How Do Debt Consolidation Loans Work?

The majority of debt consolidation loans are fixed-rate installment loans; this means that you make repayments of the same value over a certain period of time. 

This means that if you have multiple debts with different interest rates and minimum payments, using a debt consolidation loan to pay off the multiple debts means that your payments are streamlined to just one monthly payment.

What Are The Benefits of Debt Consolidation Loans?

One of the primary reasons a debt consolidation loan is typically required is to reduce the chances of the borrower falling into further and unmanageable levels of debt, sometimes referred to as a ‘debt spiral.’ Ultimately, those requiring debt consolidation loans are seeking to consolidate their debts to act responsibly in a financial sense.

There are many reasons why one might benefit from a debt consolidation loan:

  • Pay Off Debts Quicker – Debt consolidations can put you on track to pay off your overall debt faster rather than constantly making the minimum payment on multiple debts
  • Save On Interest Costs – With the right debt consolidation loan, you could benefit from a lower interest rate meaning that you will save money in the long run. The interest rate for personal loans is typically significantly lower than that of a credit card
  • Manageable Payments – Debt consolidation loans simplify your debt payments to just one monthly payment rather than multiple payments which have different due dates and different amounts. This means it is less likely that you will miss a payment
  • Easier To Plan – The majority of debt consolidation loans are fixed installment loans which means that you will pay the exact same value each month. This makes it easier to budget and keep track of.

What Are the Disadvantages of Debt Consolidation Loans?

Much like any loan or financial product in the UK, there are some downsides to consider before deciding whether or not to take out a debt consolidation loan: 

  • You Could End Up Paying More Interest – Depending on your existing debt and many factors such as your credit rating, debt-to-income ratio and the amount of the loan, you could end up paying a higher interest rate on your debt consolidation loan than you would on your original debt.
  • You May Incur Extra Fees – There may be some upfront fees initially such as balance transfer fees, early repayment penalties, annual fees and origination fees. You should look into these before taking out the loan and make sure that you are in fact saving money
  • It Is Not a Quick Fix For All Financial Problems – If you have already landed yourself in debt, you should assess your financial habits as it could be that you are at risk of getting into debt again once your other debt has been paid off

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