Consolidation loans are marketed as loans that help you ease the burden of debt payments. When you are struggling with multiple debts, you can apply for a new personal loan, which you can use to discharge existing outstanding debts. Afterwards, you will be left with only one personal loan to pay off. As they are paid back in fixed instalments, you will not struggle to settle your dues.
Consolidation is marketed as a magic bullet, but the fact is that they are not as exact as it is marketed. Consolidation is a method. It may or may not work for you. It is not like a magic wand that you wave and all your debt obligations disappear into thin air.
Mysterious facts about debt consolidation you must know
When you research the market, you find that consolidation could be a great way to get out of debt, but there are various things that they do not reveal about it.
Consolidation loans are not meant for subprime borrowers
An unsecured debt consolidation loan for bad credit usually does not exist. Most lenders do not sign off on your application if they find your score is already worse. If any lender signs off on your application, they will restrict the loan amount.
Consolidation is feasible if you have a good credit rating. If you have been struggling with debt, you should talk to your lender and explore your options before missing payments.
All outstanding loans cannot be consolidated
First off, keep in mind that consolidation loans do not add to credit card debt and instalment loans such as mortgages, auto loans and other instalment loans. Consolidation loans only include short-term debts required to be paid off in one fell swoop.
While lenders claim that they can consolidate debt as high as £5.000, the fact is that most of them cap at £1,000. It means that despite applying for a new personal loan, you will have to settle some of your obligations on your own.
There is no guarantee that a lender will combine all of your outstanding debts.
You are reborrowing through consolidation
Consolidation is regarded as a solution to your debt problems. Unfortunately, you are simply reborrowing. For instance, you have four different types of short-term loans, each of £1,000. If you consolidate all of them, you will have to take out a personal loan of £4,000 to pay them off once and for all.
After the settlement of existing debts, you would still have £4,000 to be paid off over an extended duration. So, on no account is consolidation helping you reduce your obligations.
Lower payments are a trap
Consolidation loans furnish you with lower monthly payment plans. Many borrowers assume that they are cheaper than a lump sum debt payment. However, the fact is that lower monthly payments do not mean that the total cost of the debt is low. Lenders usually extend the repayment term beyond a year, as this lets them earn a significant amount on interest. The total interest payment will be much higher if the loan term is longer.
It does not solve the underlying problems
If you get stuck in debt, you will have to come up with a solution to get out of it. There are loads of strategies apart from consolidation, such as debt avalanche and debt snowball, but none of them can preclude you from falling into debt in the future unless you mend your ways.
First off, you need to identify what caused you to get into debt. Unless you identify the cause, you cannot come up with a strategy to prevent yourself from being trapped in an ongoing cycle of debt.
For instance, if you overspend money, you should try changing your spending habits so you do not face debt problems down the track. Consolidation loans do not erase debt. They just transfer it from one source to another.
They are subject to hidden fees
Consolidation loans will charge upfront fees, which are usually between 3% and 5% of the total amount of the debt. Apart from the processing fees, you will be charged hidden fees as well. You will come to know about these fees at the time of signing the agreement.
Be careful while reading the fine print. Do not sign the agreement unless you know how much it will cost you. Ask your lender if you have any doubts about the total cost of the debt.
Consolidation can damage your credit score
Consolidation loans are thought to help you improve your credit score because you will pay off the debt over a long duration. Do not forget that consolidation will reflect on your credit report, and this will be perceived as risky. Lenders would believe that you never manage money responsibly, and therefore, you have to consolidate your existing debts.
Is consolidation actually an effective idea to deal with debt struggles?
| When debt consolidation is effective | When consolidation worsens your situation |
| Your credit score is good, and it lets you qualify for lower interest rates. | You are not addressing the underlying causes of falling into debt. There is no point in consolidation if you have to again max out credit cards or rack up debts. |
| It helps you save some money in total interest payments as compared to existing debts. | You are choosing a longer repayment term. This will increase the total interest payment. |
| It simplifies finances, and you are absolutely certain that you will not fall into debt again. | Fees are high, and consolidation does not help you save any money at all. |
| It provides you with mental peace. | There is a risk of losing your asset. |
The bottom line
There are several facts about consolidation loans that lenders do not reveal. You should carefully analyse whether they are actually helping you save money. Otherwise, use other methods to get out of debt, such as a debt avalanche and a debt snowball. Make sure you change your habits so you do not get caught up in debt again.
Also read what counts as a good credit score how to improve it?
