Debt consolidation is when you use one form of credit to pay off multiple other forms of credit.
For example, you take out a personal loan to pay off multiple credit cards, store cards or a payday loan.
It’s a popular topic online and a subject many people seem to be unsure about.
What is debt consolidation?
As I mentioned in the intro, debt consolidation is where you pay off all your debts with one larger debt.
This is most typically done with a personal loan. You take out a loan large enough to pay off all, or the majority of your other debts to clear them all.
Rather than having multiple payments with multiple interest rates, you have one payment.
Personal loan rates are much lower than credit card, payday loan and many other forms of credit so can work out cheaper to service.
This gives you more money to pay off the debt faster.
How does debt consolidation work?
The reason debt consolidation is so popular is because it’s very easy to set up.
As long as you can qualify for a loan large enough to pay off all your cards or other debts, you can set it up in hours.
The process is very straightforward:
- Calculate the total of all your debts
- Check with an affordability calculator whether you can qualify for a loan to cover them all
- Make sure you can afford the new monthly payment
- Compare loan rates and get pre-approved if you can
- Apply for the loan
- Pay off everything as quickly as you can
That’s pretty much all there is to consolidating debt.
As long as you know how much you need in order to pay everything off and can qualify for a loan to do that, the rest is easy.
I definitely recommend getting pre-qualified first. It’s a quick check to make sure you’re able to get the loan you’re applying for and minimises any hard enquiries on your credit report.
Once done, you’ll have one single monthly payment at a lower rate than most cards and payday loans.
You can do the same with a 0% credit card as well. If you don’t want a personal loan, you can use snowballing or stoozing to pay off other debt at 0% interest.
A balance transfer card would be cheaper for smaller debts.
A personal loan will be more suitable for higher levels of debt.
Pros of debt consolidation
Debt consolidation can be a good idea for many people who owe money but it may not be for everyone.
Simplify your finances
Debt consolidation takes many debt payments at a range of interest rates and brings them altogether into a single payment.
Lower monthly payments
Depending on the arrangement, you could drastically lower your monthly debt payment. That can make life easier to manage or allows you to overpay the loan.
Less chances of defaulting
Whether through affording all the payments or remembering to pay everyone, managing a single payment rather than multiple payments is definitely easier to manage.
Lower interest
If you use a personal loan, it will be many times cheaper than credit or store card interest. If you’re also settling a payday loan, you’ll be saving a lot of money!
Reducing revolving credit
If your credit utilisation is over 30%, paying off your credit cards could bring you under, which will have a beneficial effect on your credit score.
Cons of debt consolidation
There are potential downsides to debt consolidation though:
Potentially paying more interest over time
Depending on how you consolidate, you may be paying a lower rate but you could be paying it over a longer term. While more affordable, it could mean paying more in interest.
Doesn’t address reason for debt
A consolidation loan doesn’t address the underlying reason for being in debt in the first place. There may be behavioural changes or improvements in budgeting required.
Hard enquiry on your credit report
An extra hard enquiry to arrange the loan is a minor issue but may come into play if you’re planning to move home or need to remortgage anytime soon.
Consolidating debt
Consolidating debt can be a good thing if you can also tackle the reason you got into debt in the first place.
It’s not a get out of jail free card, you’ll still need to pay it off and manage the debt.
If it was spending that got you into debt, some behavioural changes will be necessary to avoid getting further into debt.
If it was just the financial situation, some creative budgeting may be necessary to be able to afford all your outgoings so things don’t get worse.
If you do find yourself in a situation where debt consolidation becomes a possibility, I recommend getting some help from a professional first. A blog post can only tell you so much!
