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What is a Debt Consolidation Loan?


What is a Debt Consolidation Loan?

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A Debt Consolidation Loan is a method available to people who are struggling with their debts. Essentially, it involves someone taking out a large, substantial loan to pay off all their other loans, so that they only have one debt to worry about and pay off. This can make debt more manageable, but it is not perfect for every debt situation.

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The Loan

A number of banks have different offers on consolidation loans. They will offer different interest rates, amounts and repayment terms. As the loans are designed to help people in debt pay off their debts, it could be possible to find a loan even if your credit score is not particularly good. However, poor credit scores will limit your ability to take out any loan, and will increase your interest rates.

As it is an informal debt solution, a debt consolidation loan will not be recorded on any insolvency registers, but you are also not entitled to have any interest frozen, debts written off, and everything, such as contacting and communicating with your creditors, must be handled by you.

The Repayment

The most important aspect of a consolidation loan to consider is the repayment. Most of the time, a consolidation loan will mean that you are repaying over a longer period of time. Even if you have managed to lower your monthly payments, a higher interest and longer payment term will mean you are ultimately spending more.

It is very important that you calculate your monthly expendable income, are aware how long it will take to pay back the entire loan and are aware of how much this will cost in total. This is because if you do manage to successfully use a debt consolidation loan, it may mean that you are not just debt-free at the end of the repayments, but you could also improve your credit score.

By repaying a large loan, such as a debt consolidation loan, you are demonstrating that you are financially responsible and stable. These are the attributes that credit report agencies are looking for when they compile your credit report and determine your credit score. A great credit score will allow you to have better interest rates in the future, and will put you in a good position if you are planning on buying a house, car, or other major asset, in the near future.

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An Example

Anna has three separate debts with remaining balances of £3,000 at 3% for 3 more years, £1000 at 5% for 4 more years and £500 at 9.9% for 2 more years. This means she has:

  • Loans to repay of £4,500
  • A monthly repayment total of £87.19 + £22.98 + £22.95 = £133.12
  • A total repayable amount of £3138.84 + £1102.99 + £550.85 = £4792.68

She only has £90 a month that she can afford to put towards her loans, so she takes out a consolidation loan of £4,500 at 4.9% for 5 years.

  • Now there is only one monthly payment of £84.50
  • But the total repayable amount is £5,069.70

She has made her debts more manageable and affordable, but, ultimately, she will be paying more as she has to pay over a longer period of time.