Some consumers turn to debt consolidation when they realise their financial situation could look better. Rather than to struggle with too many bills, and only being able to make the minimum payments on these accounts, they consolidate the debt into one payment. These consumers make one monthly payment over a specified period to pay off the debt. This could help them improve both their cash flow and their credit profile should they keep up with this plan.

The main benefit of debt consolidation is that it is most often a single loan, so consumers do not need to make separate payments to various lenders each month. Another reason why so many people decide to consolidate is that they may receive a better interest rate with the new lender.

These loans are often secured, although unsecured debt consolidation loans do exist. Consumers often secure the loan to their property, which offers them reduced interest rates. They decide whether they want to pay off all their debt or only a portion of it. Typical uses for debt consolidation loans are paying off credit cards and store cards; clearing overdrafts and bank loans; and using the money to finish off hire purchase agreements.

Who considers Debt Consolidation?

The average Debt Consolidation consumer is either a person who is in full-time employment who may be struggling with debts, or may be financially mature to realise what savings debt consolidating can bring. Various studies have been done by the OFT and they found that individuals who apply for a secured loan provide Debt Consolidation as their main reason for doing so.

Advantages to Debt Consolidation

• Potentially lower interest rates on secured loans
• Possibly lower monthly payments
• It can be a single loan so there is only one creditor

Disadvantages to Debt Consolidation

• Early settlement charges on existing loans when taking out a consolidation loan
• Broker fees and commissions
• Overall borrowing is higher because loan is spread over a longer period

Debt Consolidation versus Debt Management

What is the difference between these? Whilst Debt Consolidation is opening up a new line of credit, a typical debt management plan addresses how to make your unsecured debts more affordable without further borrowing and starts by considering what you can afford to repay each month.

The Debt Management company may negotiate for lower monthly payments by asking creditors to freeze or lower interest rates and not to add more charges to your account.

The debt management company would work on your behalf and distribute your payments to the various creditors.

A potential drawback to debt management plans is if not all your creditors agree to your proposed payment plan. All your creditors have to accept the payments that are made to them on your behalf, but if they have not accepted the plan they might still penalise you with interest and other charges because you are defaulting on the original payment plan.

Debt consolidation options

What other options are there besides consolidation loans?

Individual Voluntary Arrangements – A legal agreement between a creditor and a debtor to repay the debt and avoid bankruptcy.

Remortgages – Switching to a new lender may result in a lower interest rate and consumers use the equity to pay off existing debt. Such loans are normally spread over a long term, so consumers should always consider what effect this will have on their finances over the term of the loan.

Debt Management Plans – These plans negotiate a longer repayment period, and debtors only make one monthly payment to the Debt Management Company.

Bankruptcy – Bankruptcy frees consumers from debts they cannot afford. Assets are sold off to pay creditors. This option, however, should always be a consumer’s last resort.

Other important things to consider

Do some careful thinking before taking out any type of debt consolidation offer. What is the best option for your situation? Would it be best to apply for a debt management plan, or would a remortgage loan suit you better?

The Annual Percentage Rate (APR) should be your guide when deciding which option is best. When you take out a loan, the number of repayments you must make, and the exact date they must be paid by, will be clearly stated in your loan agreement. As these details are defined precisely, the annual rate of interest over the period of the loan can be calculated exactly and must be shown on advertisements by law. All arrangement fees and any other costs must be included in the calculation. You can therefore be certain that the APR quoted is a safe and sure way to compare two or more loan quotations; the one with the lowest APR being the best value and will cost you less money.