We're swamped by adverts for consolidation loans but when is this form of borrowing really the answer for those in debt?
Consolidation loans are typically used to combine multiple financial commitments into a single loan with more affordable monthly repayments. They can take many shapes and will either be secured against your property (a secured loan or further advance on your mortgage) or unsecured (a personal loan or credit card).
While consolidation loans are often painted as the wonder solution to all financial difficulties, they aren't always the answer. However, that's not to say that they don't have their uses; when used appropriately they can ease financial strain and even help you to repay your debts sooner than you would otherwise have been able. We balance the pros and cons.....
Consolidation pros
- If you're struggling to meet repayments on multiple loans and credit cards consolidating your debts into a more affordable commitment can be a good solution. By doing this you will be able to focus on meeting a single, fixed repayment each month until the debt is fully repaid and will avoid the temptation of only paying the minimum on your credit card bills.
- If you are paying a high rate of interest on existing borrowing and are carrying interest-accumulating balances on your credit cards, consolidating your expensive debts using a low rate loan or credit card will enable you to clear your outstanding in a much shorter period of time. This is because a lower percentage of your monthly repayment will be allocated to interest and more to paying off the principle.
- If you shop around and consolidate your finances with a fixed rate unsecured loan that allows for overpayments you will have optimum flexibility to clear your debts as soon as possible. The longer the loan term the more you end up paying in interest so make sure you agree monthly repayments that are affordable but that will clear your debt as quickly as possible.
Consolidating cons
- If you go down the consolidation pathway as a means of making your debt more affordable there is a distinct possibility that you may actually end up paying more interest over the course of the loan that you would have done if you'd have stayed as you were. This is especially the case if you spread your repayments over a longer term than you are currently repaying. When deciding whether consolidation is the right option to you, you'll need to balance the affordability of spreading your payments with the possibility that you may end up paying more in the long run.
- The only way to make consolidating your debts worthwhile is by curbing your spending and focusing on paying off your new loan. It can be awfully tempting to start spending on cleared credit cards but if you're not careful you'll be in twice as much debt as you were before and still unable to pay off what you owe. You should only consider taking out a consolidation loan if you realistically think that you'll be able to resist taking on any additional debt for at least the period of the new loan.
- A huge number of consolidation adverts grace our tv screens, many of which encouraging us to borrow a little extra while we consolidate to treat ourselves to a dream holiday or new car. If you're serious about clearing your outstanding debts you should only borrow what you need to repay your existing commitments when you consolidate.
- Many loan providers impose an early repayment charge if you try to leave your loan contract during the agreed term. So before you consolidate you will need to check the t's and c's of your current commitments to make sure that paying them off early is going to be worth your while. In theory it's only worth refinancing a loan if it is going to be cheaper for you in the long run, early repayment charges may make consolidating more expensive even if your new interest rate will be lower so its important to do the maths before you commit.
Which loan should I use to consolidate?
Generally any loan you use to consolidate your finances should be unsecured (so that your property isn't at risk if you can't meet repayments), flexible (with the option to make early and over repayments), with an interest rate that is lower than you are currently paying.
You don't need to consolidate all of your debts, only those with a higher interest rate than you are currently paying otherwise the move will be counterproductive and will cost you more in interest payments.
In conclusion....
While consolidating isn't always the ideal option, when done properly it can be a realistic way to manage your finances. By doing the sums and weighing up the pros and cons before you commit you will be able to decide whether this option is right for you.
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