We will all borrow money at some point in our lives.
This could be on a credit card, personal loan or maybe a mortgage or car finance. Occasionally, these debt repayments can overwhelm your monthly finances, affecting your cashflow and affordability.
One option to help deal with this type of situation is called debt consolidation and it’s a way of streamlining your debts so they are more affordable. In this article we run through what debt consolidation means and how it works in practise.
What is debt consolidation?
Debt consolidation is when you take out a new loan (or mortgage) and this is used to pay off several different debts that you already have, e.g. loans, overdraft credit cards.
It doesn’t mean that these debts are gone, but it does remove the stress of dealing with different lenders.
While some lenders will offer specific ‘debt consolidation’ loans, you can use most standard personal loans for debt consolidation purposes and the same options apply for mortgages and remortgages.
Suitable debts for consolidation
Credit Card Debt
Credit card debt is one of the most common forms of debt that can be consolidated. Many people accumulate multiple credit cards, each with their own interest rates. Interest rates on these can be very high.
Personal Loans
Personal loans often have competitive interest rates but if you have more than one loan, the overall monthly cost can be a burden. Debt consolidation would enable these to be converted into one loan, and normally over a longer period of time.
Store Card Debts
Store cards, or retailer/shop cards, can be convenient but they often carry higher than normal interest rates. These can be consolidated and repaid as with credit cards.
Overdrafts
Overdrafts and other lines of credit can be consolidated as well. Overdrafts can have high interest rates, especially if unauthorised, with some banks charging fees in addition.
Payday Loans
Payday loans are for relatively small sums, set over short periods, and would not normally be included for debt consolidation. But some lenders are now offering longer terms and the interest rates will be high. So it could make sense to repay these as well, helping you to completely move away from this type of lender.
How does debt consolidation work?
Debt consolidation works by taking out a new loan, or mortgage, and then using this money to repay multiple debts such as: credit cards, loans etc.
This reduces the number of monthly payments that you need to keep track of.
Debt consolidation can be used in this way to just make your finances a bit simpler, as you’ll only have one lender and one payment to worry about.
But for many borrowers the main priority will be to lower the overall monthly payments and/or reduce the rate of interest on the debt.
Work out what you owe
Carefully add up all of your unsecured debts, to see how much you need to borrow. Don’t forget to add in any fees to close the accounts.
Get the right finance
Find the loan or mortgage that suits you best. Different term lengths will affect the monthly payments. Take some financial advice to help you.
Pay off the debts
Once the new loan is approved the lender will send you the money. Use this as quickly as possible to fully repay your more expensive unsecured debts.
Repay the new loan
Keep up the repayments on the new loan, and gradually you will reduce the amount you owe. Resist the urge to start using your credit cards again.
will it be worth it?
For
Consolidating unsecured debts can allow you to get a better rate of interest and combine all of your payments into just one monthly cost.
Having a more manageable payment can help with your monthly budgeting and avoid getting any bad credit.
Credit and store card balances will be repaid in a structured way, over the term of the loan.
If you were struggling with your monthly bills then bringing them all under one loan should be less stressful.
Against
The main downside for most people is that you could pay more interest on your debts than before.
Despite borrowing at a cheaper rate of interest, if you spread the debt repayment over a much longer period of time, you’ll be paying interest for longer as well.
In addition, you will need some strong willpower to curb your expenditure, without resorting back to credit cards and loans.
Once they have been paid off, it’s best to cancel most of the cards, or ask the bank to reduce your limit.
Things to consider
Will you end up paying more?
While consolidating your debts will reduce the amount of stress and effort of managing different payments, you should check how much it will cost you overall.
Even with a lower interest rate, the new arrangement could cost you more in interest charges.
Can you afford the new payments?
Don’t rush in to anything. Take some time to consider how affordable the new loan will be.
Are there early repayment fees?
Before you pay them off, check your current debts for exit fees or early repayment fees. If applicable, these fees will increase the amount you need to borrow.
You’ll need the right credit score
Debt consolidation works because it spreads the repayments over a longer period of time. But the interest rate payable still needs to be competitive. Check your credit report and take some action if your credit score is too low, otherwise you won’t qualify for the better deals.
There are two types of debt consolidation loan
Unsecured loans
Unsecured loans are usually personal loans and the ‘unsecured’ part means they are not linked to your property or any other assets.
This means that your credit score has more of an influence on whether you will be accepted and at what interest rate.
Borrow between £1,000 and £50,000 over 1-7 years.
Secured loans
Secured debt consolidation loans can be set up as mortgages or second charge loans.
Both are effectively mortgages that are ‘secured’ against your home. As you are putting up your home as security, the lenders can be slightly more relaxed with bad credit or less than perfect credit scores.
There’s no set limit on how much you can borrow, and repayment terms can be over 10-25 years.
CONTACT A REMORTGAGE EXPERT
If you wish to investigate your re-mortgage options we can put you in touch with a fully qualified whole of market mortgage broker.
Is a debt consolidation remortgage a good option?
Remortgaging your home can be a useful way to consolidate debt and reduce your monthly payments.
You would apply to a new mortgage lender for a higher loan amount than you have now. The extra amount borrowed needs to be enough to cover all the unsecured debts that you wish to pay off.
Debt consolidation mortgages are freely available and you will have a choice of interest rates and the repayment term length.
If your main mortgage will incur ERC’s on repayment, then it may be worthwhile looking at a secured loan to raise the debt repayment element, as this leaves your main mortgage in place.
Mortgages are repaid over longer periods than standard personal loans, so the ‘consolidated debt’ part will probably cost you more in interest.
As always, seek advice first.
Ask about splitting the two loans
If you are choosing to go with a debt consolidation remortgage then you might want to investigate having the new mortgage set up as two loans.
This isn’t available from all lenders, so ask your mortgage broker if this is possible and how it would work for you.
Let’s imagine that you currently have a £200,000 mortgage, with another £50,000 owed across various cards and loans. You want to consolidate all of the debts.
OPTION 1
Apply for a remortgage of £250,000 over 25 years.
OPTION 2
Apply for a remortgage set up as follows:
- Loan One: £200,000 over 25 years
- Loan Two: £50,000 over 15 years
Doing this will still enable you to pay off your unsecured debts and should save you money each month.
But, the extra £50,000 you have borrowed will be paid off more quickly and cost you less in interest.
Just an idea!
Debt Consolidation Mortgages
In this guide, we explain what debt consolidation is and how a remortgage can help you to pay off your debts and reduce your monthly payments. We’ll also share some tips on choosing the right debt consolidation plan for your needs.
“Your home may be repossessed if you do not keep up repayments on your mortgage”
Your main mortgage is linked to your home, the lender takes a legal charge over it for extra security. If you get into mortgage arrears then there is the possibility that the lender will repossess your home and sell it to pay the debt.
“Think carefully before securing other debts against your home. Your home may be repossessed if you do not keep up repayments on your mortgage”
If you use a mortgage, or secured loan, to consolidate debt then this will increase the debt burden attached to your home. It also reduces your equity. As before, if you get into mortgage arrears then there is the possibility that the lender will repossess your home and sell it to pay the debt.
“Consolidating debt may reduce your outgoings now, however you may pay more interest over your mortgage term”
Most people expect to pay less each month after debt consolidation, easing the financial pressure on their monthly payments. The way this is achieved is by spreading the debt over a longer period of time. Although a debt consolidation remortgage is likely to have a lower interest rate than the debts it replaces, the fact that the repayments go on for longer usually means that the overall interest paid over the term is higher.
