Consolidating is a process of combining all your existing multiple debts into one large personal loan to be paid down in fixed monthly instalments. Suppose you have three short-term high-cost debts which amount to £3,500 in the aggregate. You will take out a new personal loan of £3,500 to pay off all your existing outstanding debts once and for all, so that you will have only one loan left to be paid down over a period of months. Consolidation seems to be the best strategy when you are struggling to keep up with payments, but there is more to it than meets the eye.
There are a few points that you must know about consolidation loans:
- Consolidation loans do not include credit card debt. If you have an outstanding balance on multiple credit cards, you will need to apply for a balance transfer card.
- Consolidation loans do not include instalment loans, whether they are short-term or long-term. They would rather include short-term high-cost debt such as payday loans, bad credit loans, and the like, which are paid off in one fell swoop and rolled over every time you fail to discharge the balance in full.
- Consolidation loans are short-term loans. No lender is under an obligation to combine all your existing outstanding debts. Mostly, borrowers have to manage a few debt payments separately, along with consolidation loans.
- Consolidation loans require you to have a decent credit report to qualify. While some lenders might accept applications from subprime borrowers, they will charge high interest rates and restrict the loan amount.
Even if you can qualify for consolidation loans, there are certain things you must bear in mind. Careful planning is a must to ensure smooth repayments of consolidation loans.
What is the size of your budget?
Before consolidating your debts or taking out a new credit, you should work on your budget. You must determine how much money you are left with after paying your day-to-day living costs. Make sure that you will have enough money to keep up with the repayments of a consolidation loan. Your budget must be realistic and accommodated to your current financial circumstances. The ultimate goal of analysing your budget is to determine:
- How much you can afford to pay towards a consolidation loan
- Whether you can pay off your existing debts if a consolidation loan is restricted.
It is vital to bear in mind that if you take out a new loan to consolidate existing debts but struggle to keep up with payments, you will end up paying a lot more than you originally borrowed. Inability to make payments will have far-reaching effects on your credit score as well as your financial condition. The credit damage will be so severe that you will not be able to fix it soon in years to come.
If you are not completely certain about your repayment capacity, you should talk to a debt advisor and consider suitable options.
Will you be able to save money?
Emergencies never knock on your door before they crop up. While preparing a budget, you should see if there is a scope to save money. Savings should never be underestimated, even if you are to pay off some debt. Undoubtedly, savings can help you save money in the future, as you will not have to borrow money to meet unexpected expenses. It is enjoined that you should try to save money on your everyday bills. For instance:
- You can reduce the consumption of the heating system to save money on energy bills. Put on extra layers when it is too cold.
- Consider saving money on your grocery bills. If your financial condition is not good enough or you have accumulated too much debt, you should try to eat cheap staple foods such as potatoes, rice, macaroni, pasta, etc.
- Discretionary expenses must be halted unless debt loosens the grip. By sticking to essential expenses only, you will be able to stash away some money
- Bulk purchase, even though it helps save some money, is not advisable as long as you have debt to settle.
Have you checked the overall cost?
It is important to focus on the overall cost, especially if you miss payments. The APR for loans for consolidation is also high. If you miss payments on a consolidation loan, you will be asked to repay the debt in full. As a result, you will end up owing a lot more money than you had before consolidating your existing debts.
Even if you are sure about your repayment capacity, do not forget to assess interest rates. Consolidation loans are usually expensive. The most affordable deals are available for borrowers with decent credit scores. If your credit rating is not impressive, you will be charged high interest rates. It is vital to shop around before grabbing any first offer.
Have you addressed the reason for falling into debt?
Consolidation loans cannot reduce the size of the debt. They simply replace multiple debts with one big loan. If you do not address the reason for plunging into an abyss of debt, you will find yourself accumulating much more debt. It is likely that your financial struggle will still be the same after consolidating your existing debts. If that is the case, you will not be able to stick to repayments or continue to borrow money to meet your day-to-day expenses.
Analyse your bank statement to check if:
- You have been overspending money.
- You have never set aside money for a rainy day, and therefore, you tend to borrow money frequently.
- You are living beyond your means.
If you find that debt consolidation is not a suitable option for you, try considering a debt management plan or other alternatives.
The bottom line
Consolidation loans could help you deal with outstanding debts, but they are not a solution to problem debt. You should try to address the reason for accumulating debt, so you can release yourself from a debt clutch.
