When Is a Debt Consolidation Loan a Good Idea?

If you are struggling to make your monthly repayments on multiple loans and credit cards, then you may have thought about debt consolidation loans. 

For some people, debt consolidation can be a great option. However, as with taking any loan, it’s important that you consider all of the information before making a decision.

What is a debt consolidation loan?

A debt consolidation loan is a way of taking multiple debts and their associated repayments, and consolidating them into one (hopefully smaller overall) repayment. 

The basic idea is that you take out a personal loan from a lender. You then use this loan to pay off all of your debts. This means that you only have one monthly payment to worry about.

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When are they a good idea?

If you have a lot of different payments to manage each month and you are struggling to remember to make them, then debt consolidation loans can be a good way to help you to feel more in control of your finances. Missing payments can impact your credit score, and having your loans consolidated into one can help you to avoid this.

A debt consolidation loan may also result in a monthly payment that is overall lower than your other payments combined. This is good news if you are struggling to afford your monthly repayments at the moment.

Having a lower monthly repayment gives you greater financial freedom each month, which means that you can do things like starting to save money.

Things to consider

When you are thinking about consolidating your debt there are a few things to consider which will impact whether or not it’s a good idea for you.

A consolidation loan will generally have a lower interest rate than your current debts, which is great news in the short term. However, the repayment period is often longer so the amount of interest you pay across the term of the loan can end up being greater. This is something that you should calculate and take into account when thinking about a consolidation loan. 

You can mitigate this by saving the extra money that you would have been making each month on your repayments, and using it to over-pay on your consolidation loan. This will mean that you can clear it much more quickly, and therefore pay less interest overall. 

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It’s also good to take a look at your current debts and make sure that you will be able to pay them off with a consolidation loan without incurring penalties. Some debts come with an early repayment charge, which can make it less cost-effective to pay them off early.

Finally, taking out a new loan will have a temporary negative impact on your credit rating. If you use the loan to pay off debt your credit rating will improve over the longer term, but it is worth bearing in mind that there will be a short-term impact.