A Guide to Debt Consolidation

The number of households with large debts increased by a third in 2021. There are a number of factors behind this, including the Covid pandemic, as well as low wages, job insecurity, welfare cuts and the rising costs of living.

As such, many households are finding themselves in situations of cyclical debt, whether this be through loans or outstanding credit card bills. Further, with interest rates on the rise, many are struggling to pay off the growing interest on their outstanding repayments, especially if they have multiple.

In order to overcome the stress of this, many are turning to debt consolidation.

Debt consolidation refers to when an individual’s multiple debts, including credit cards, overdrafts and loans are merged into a single and more affordable loan. By doing so, this can help to simplify repayments and pay off a loan to become eventually debt-free against all your financial liabilities. 

Who is Eligible for Debt Consolidation?

In order to be eligible for a debt consolidation loan, the borrower must meet the following criteria:

  • They must be a resident
  • They must be able to afford monthly repayments
  • They must be in receipt of a regular monthly income
  • For secured loans, they must have an asset of value such as a property or car
  • For unsecured loans, they must have a fair credit rating

How Does Debt Consolidation Work?

Debt consolidation loans allow an individual to compile all of their existing debts, such as credit cards, loans, student loans and overdrafts, into one single loan. This will then be taken as a single monthly payment and should have a lower interest rate. 

By compiling the multiple outstanding debts into one, the individual no longer has to worry about making several separate payments or interest being added to existing loans or accruing any late fees. 

When the debt consolidation loan is taken out, it immediately pays off all existing debts and then you have one loan to pay off with one provider, at ideally more favorable rates. This can help to clear off some of these debts sooner than expected as well as help to avoid any additional interest or late payment fees

Debt consolidation loans are used by homeowners and tenants. There are two types of loans; unsecured and secured, so homeowners may lean towards a secured option against their property, but they could use an unsecured loan if they prefer.

Debt consolidation loans typically operate under the following terms:

  • You can borrow up to $25,000
  • Repayments take place over 1 to 30 years
  • One single repayment every month
  • Funds can be available within 48 hours of the initial loan application
  • Low cost and fixed rates are available
  • Those with poor credit scores are still considered

Types of Debt Consolidation Loans

There are two types of debt consolidation loans that you should be aware of.

Secured Debt Consolidation Loans

The main feature is that the loan will be secured against an asset of value, such as your car or home. If the loan repayments are not made on time or in full then there is the risk of losing this collateral.

The rates will often be much lower with secured loans as the collateral provides the lender with some form of expensive security.

Unsecured Debt Consolidation Loans

Debt Consolidation Unsecured loans are when the loan is not secured against any valuable assets. This means that there is no risk of losing anything if the loans are not repaid on time or in full.

In order to obtain an unsecured loan, the borrower will need to have a fair credit history as well as receive a regular income. If they do not meet the monthly repayments, then this will risk negatively impacting their credit rating making future loans more expensive due to higher rates.

How Much Can You Borrow?

Most unsecured loans allow you to borrow up to £25,000 depending on factors such as income, employment and credit score. 

For secured loans, this could depend on the value of your property or asset, as well as your income and credit score and whilst most mainstream lenders allow you to access up to £50,000, it is not surprising to be able to access up to £100,000 or £200,000.

Those with bad credit or less than perfect credit score will often be able to access debt consolidation loans, especially if they are struggling to stay on top of their debts, but you will typically need to leverage some kind of collateral or assets to be eligible.

How Does Debt Consolidation Impact Credit Scores?

When you apply for a debt consolidation loan, the lender will carry out a hard credit check on your financial history. This hard credit check leaves a visible footprint on your credit report but has no lasting impact. 

If you are approved for a debt consolidation loan and make the monthly repayment on time and in full, this will actually help to improve your credit score and can open you up for better rates for future financial products.

If you are approved for a debt consolidation loan and miss your monthly repayments, then this will negatively impact your credit score and could make future borrowing more difficult to get approved for, with more expensive rates.

A Guide to Debt Consolidation was last updated February 26th, 2024 by Emma Grant