Debt consolidation loans Q&A

·6-min read

A debt consolidation loan combines all your debts into one personal loan, typically saving you money on interest costs.

This type of loan also simplifies your payment schedule as you will only need to make one loan repayment each month.

Here’s how debt consolidation works and when you should consider it.

What is a debt consolidation loan?

A debt consolidation loan is a type of personal loan taken out to pay off other debts.

The cash from a debt consolidation loan can be used to pay off credit cards, store cards, payday loans, buy-now-pay-later deals, and overdrafts. It can also be used to pay off debts to utility companies or council tax, debt collectors and bailiffs.

The idea behind debt consolidation loans is twofold:

  • By merging all your debts into one loan, you’ll only need to make a single payment each month.

  • To reduce the overall rate of interest you pay – so you save money.

The golden rule of debt consolidation is to be disciplined enough not to start borrowing on credit cards, overdrafts and the like again – this would defeat the point of the debt consolidation loan.

How do debt consolidation loans work?

You need to do a fair amount of legwork when you take out a debt consolidation loan – paying off your other debts is not automatic.

To get started, work out how much you need to borrow. You can do this by adding up how much you owe including any penalty fees for repaying your debts early.

Next, you need to apply for a debt consolidation loan with the loan amount covering what you owe. When the loan is approved, the lender will pay the money into your bank account.

You should then manually use this cash to pay off your other loans.

Finally, you’ll need to repay your debt consolidation loan as agreed with the new lender.

How does a debt consolidation loan save me money?

Other types of borrowing such as credit cards, store card finance, buy-now-pay-later schemes, payday loans, overdrafts and some personal loans can come with high rates of interest.

Overdrafts, for example, typically have an APR of close to 40%, while most credit cards charge about 18% APR.

Debt consolidation loans generally offer competitive rates of interest compared to other forms of borrowing. So, by swapping a range of expensive debts for one debt consolidation loan you’ll reduce the total amount of interest you pay.

Interest rates are usually fixed too, providing peace of mind that your monthly repayments will not go up for the agreed loan term.

Is a debt consolidation loan secured or unsecured?

Debt consolidation loans can be secured or unsecured. But unsecured debt consolidation loans are almost always your best bet. They can save you money and you won’t need to put up your home (or anything else) as security to get one.

If you are a homeowner but have a poor credit rating, a secured debt consolidation loan might be your only option. But tread with caution – you’ll be required to put your property up as security for the loan. If you default on payments, your home could be at risk of repossession.

Over how long can I borrow with a debt consolidation loan?

Unsecured debt consolidation loans are normally available against repayment terms ranging from one year all the way up to seven.

However, secured debt consolidation loans might be for up to 25 years.

The longer the term of your debt consolidation loan, the more interest you’ll pay overall. But a shorter term will mean higher monthly payments.

What interest rate will I pay on a debt consolidation loan?

How much interest you’ll pay on a debt consolidation loan depends on:

  • how much you borrow

  • the repayment term

  • your credit rating

  • the lender and deal

Debt consolidation loans usually come with tiered interest rates. This means interest rates are normally higher for small amounts than larger amounts. The lowest interest rates are usually offered to people borrowing £7,500 or more.

Be aware that you might not get the advertised APR when you apply for a debt consolidation loan. Lenders only have to give their headline rate to 51% of successful applicants.

How much debt can you consolidate?

An unsecured debt consolidation loan is essentially just a personal loan – so the maximum loan amount will depend on the lender and your personal circumstances.

Unsecured loans normally go up to £25,000 or £30,000 in some cases. You may be able to borrow more on a secured loan.

Will a debt consolidation loan impact my credit score?

A debt consolidation has the potential to either improve or damage your credit score.

If you make your loan repayments on time, your credit score will improve. But failing to keep up with repayments will have a negative impact on your score.

When you pay off your other debts, you should close down these accounts so this credit is no longer available to you. Having too much available credit can have a negative effect on your credit score.

How much interest will I pay?

The cheapest debt consolidation loans start at about 3% APR (fixed).

If you borrow less than about £5,000, the interest rate may be higher than this.

You’ll also be charged more if you have a poor credit score – up to 99% in some cases.

Make sure you shop around before applying for a debt consolidation loan. Using a loan eligibility checker can help you discover which loans you are likely to be accepted for.

Is a debt consolidation loan a good idea?

A debt consolidation loan could help you sort out your finances if you:

  • are struggling to keep up with multiple payments each month

  • have debts with high interest rates

  • don’t know which debts to prioritise

  • will be disciplined enough to repay the debt consolidation loan

  • will save money overall

  • won’t be tempted to borrow money elsewhere

  • can afford the monthly repayments on the debt consolidation loan

What are the alternatives to a debt consolidation loan?

  • Balance transfer credit card

If the debts you want to repay are on one or more credit cards, a 0% interest balance transfer card could be a good alternative to a debt consolidation loan.

A 0% balance transfer card lets you move existing credit card debts to a new credit card charging 0% interest for a set amount of time, typically up to two years. Most balance transfer cards charge a balance transfer fee expressed as a percentage of the amount transferred.

  • Money transfer card

A money transfer credit card lets you transfer cash to your current account to pay off overdrafts, loans and other debts. Then you repay the debt at 0% interest for a set period of time.

Almost all money transfers cards charge a money transfer fee, expressed as a percentage of the amount transferred.

  • Remortgaging to release equity

If you own your home and it has increased in value, you may be able to remortgage for a higher amount to release equity. You can then use the equity to repay your debts.