A consolidation loan is a type of secured loan. It allows you to convert one or a number of unsecured loans – e.g. credit card debts, overdrafts or bank loans - into one loan secured against your property. You should think carefully before taking out a consolidated loan.
Motley Fool research found that 5/6 people who consolidate debt go on to rack up more. The Consumer Credit Counselling Service reckons that just 3% of people with debt issues should consolidate.
Consolidated loans can be helpful for some people because it may allow them to make a lower repayment every month than they had done previously on their unsecured debts.
It is also less confusing to manage one repayment per month rather multiple repayments made on unsecured debts.
However, although the repayments may be lower per month, repayments will probably have to be made over a longer period of time. This means that you will almost certainly end up paying more on your consolidated loan than on your unsecured debts. Because a consolidated loan is usually secured against your property you risk losing your home if you do not keep up with your repayments. In contrast, if you do not keep up repayments on unsecured debts the penalties are potentially less severe.
Before taking out a consolidated loan:
- Think about why you got into debt in the first place and try to change your habits so you won’t fall into the same trap in the future.
- Consider whether you want to take out more debt to repay existing debts.
- Write a budget to see if you will be able to afford repayments on a consolidated loan.
- Be confident that you will be able to use credit wisely (if you choose to use it at all) whilst repaying your consolidated loan.
- Consolidation loan companies offer a tempting "quick-fix" solution to debt - you take out one loan to cover all your existing repayments.
- Having someone else take the effort away from dealing with all your creditors may sound like a dream, but debt counsellors advise people to steer clear. This is because the interest rates charged on these loans are normally much higher than you can get on the High Street.
- They often come with payment protection insurance with unfair terms, which may not cover you if you are made redundant or fall ill.
- They are also "secured" loans, which means that if you are unable to keep up repayments you will lose the roof over your head.
- If you are sure you want to consolidate your loans into one payment, you should shop around for a competitive rate on the High Street and get a normal unsecured, personal loan.