Debt consolidation: how it works, costs and risks

Before you enquire: MoneyNerd introduces enquiries to Loans Warehouse, a credit broker, not a lender, and may receive a referral fee. MoneyNerd does not provide mortgage advice. Fees and charges may apply to the loan and broker service. Consolidating debts may increase the total amount repaid, especially over a longer term. Your home may be repossessed if you do not keep up repayments on a loan secured against it. If you are struggling with debts, seek free debt advice before borrowing more.

Debt consolidation means taking out new credit to repay existing debts. It can simplify repayments, but it does not write off what you owe and may cost more overall. This guide explains the main options, costs and risks.

MoneyNerd provides general information and introductions, not personal debt or mortgage advice. This guide covers:

• Discover what debt consolidation means and how it works.
• Learn about the different ways to consolidate debts into one payment.
• Understand the full cost and risks of a consolidation loan.
• Explore the positives and negatives of debt consolidation.
• Gain insight into debt consolidation loans in the UK and how to apply.

If you are struggling to meet essential bills or existing repayments, get free debt advice before taking on more borrowing. You can find support through MoneyHelper’s debt advice locator.

Can I consolidate all my debts into one payment?

It may be possible to repay several debts with one new loan or balance transfer, subject to approval and the types of debt involved. An IVA or Debt Management Plan is different: these arrange payments to existing creditors rather than replacing the debts with a new loan.

What is debt consolidation?

Debt consolidation is a debt mitigation strategy to consolidate multiple debts into one single debt. You might choose to consolidate all of your debts into one debt, or you may decide to consolidate just some of your debts into one new debt. 

How does debt consolidation work?

Debt consolidation works by taking out a new debt that is large enough to pay off multiple existing debts, including any fees that might be applied by repaying those debts early, such as early repayment charges. 

For example, you might pay off two existing debts equalling £1,000 by taking out one new loan for £1,000 (plus any fees payable). 

Consolidation can reduce the number of payments to manage. It only reduces the overall cost if the total amount repayable, including interest, fees and any charges for clearing existing debts, is lower. A lower interest rate or monthly payment does not guarantee a saving, especially if repayment takes longer.

Learn more about the process and benefits on our How Does Debt Consolidation Work? post.

Types of consolidation

There are different methods of debt consolidation. The types of debt consolidation available to you and the most suitable method will depend on personal circumstances, such as:

• The types of existing debts you wish to consolidate
• Whether or not you own property
• How much home equity you have
• Your income, outgoings, credit history and the lender’s criteria

To explain this further, we’ve outlined the different methods of debt consolidation below:

1. Unsecured debt consolidation loans

Unsecured debt consolidation loans are personal loans specifically marketed for people who want to consolidate debts. As these loans are unsecured, you can get approved for them without having to list an asset as security within the agreement, so you won’t need to own a property. 

If approved, the new borrowing is used to clear the agreed existing debts, either by you or directly by the lender. You then repay the new loan. Compare the total amount repayable, term, fees and affordability with keeping the existing debts before deciding.

2. Secured debt consolidation loans

A secured debt consolidation loan works in the same way as an unsecured debt consolidation loan but with one important difference. These loans are secured, which requires the debtor to list an asset as collateral within the credit agreement. The asset used is usually a property.

Securing previously unsecured debts against your home changes the risk: your home may be repossessed if you do not keep up repayments. Even if the rate is lower, fees and a longer term may mean you pay more overall. Get appropriate advice before securing debts against your property.

3. Balance transfer credit cards

Balance transfer cards are often used to consolidate credit card debts, although it’s not impossible to consolidate existing credit card debts by taking out a loan either. The balance transfer card is a specific credit card made to help people move the balance of existing credit cards to the balance transfer card. Thus, the debtor would only have one (larger) credit card debt.  

Balance transfers may have a fee. Some cards offer an introductory 0% or low-interest period, subject to approval and terms. Compare the transfer fee, the length of that period and the rate afterwards. A saving depends on the total cost and how much you can repay before the offer ends.

4. Debt consolidation mortgage

A debt consolidation mortgage describes mortgage borrowing used to repay other debts. The rate depends on the lender, product and your circumstances. Compare the total amount repayable, including fees and the full term, rather than the interest rate alone. 

You might be able to borrow more from your mortgage lender or remortgage to repay other debts. This increases the borrowing secured against your home. It can cost more overall if debts are spread over a longer mortgage term, even at a lower rate, and your home may be repossessed if repayments are not maintained.

To be able to extend your mortgage or remortgage and borrow extra, you’ll need sufficient home equity in your property as this is what you’re borrowing against. You can calculate your home equity by subtracting all debts secured against your property (usually just your mortgage unless you have home equity loans as well) from the property’s current market value. 

5. Alternatives to debt consolidation

Other ways of dealing with debt, such as an IVA or DMP, may involve one payment to a provider for the debts included. You still need to pay essential bills and any excluded debts separately. Eligibility, fees and credit-record effects differ, so get debt advice about the options available where you live.

These are alternatives to consolidation, not consolidation loans. They do not require a new loan to repay your existing creditors. A DMP is an informal repayment arrangement and does not guarantee that creditors will freeze interest or stop recovery action. An IVA is a formal insolvency arrangement available in England, Wales and Northern Ireland, with different procedures. It needs creditor approval, has fees and spending restrictions, affects credit and is recorded on a public register. Only included debts can be released after successful completion; failure can lead to bankruptcy. Scotland has different options.

What are the pros and cons of debt consolidation?

There are several benefits and drawbacks of using a debt consolidation method. 

Some of the pros and cons might be specific to the type of debt consolidation you use. Below we have outlined the most recognised pros and cons.

The pros:

1. Debt consolidation can reduce the number of monthly repayments
2. Fewer repayment dates may make budgeting simpler, but consolidation does not make unaffordable payments affordable or prevent arrears
3. Keeping up with affordable repayments can support your credit history, but score improvements are not guaranteed
4. You may save money if the total cost, including fees and interest over the full term, is lower

The cons:

1. You may not be approved to borrow more credit and therefore won’t be able to use debt consolidation
2. You might have to pay additional fees and charges, such as early repayment charges or balance transfer fees on credit cards
3. A longer term can increase the total cost. Secured borrowing puts your home at risk of repossession if you cannot keep up repayments.

Debt consolidation loans in the UK

UK banks and online lenders offer loans specifically for debt consolidation. These loans can be secured or unsecured. The interest rates can be fixed and variable, which will depend on the lender. 

You might not have to use a loan that has been specifically marketed for debt consolidation. You can often use generic personal loans to access credit and then use the money to consolidate your debts. But always check before applying. 

Debt consolidation loans eligibility criteria

Eligibility varies by lender and product. Lenders assess factors such as age, residency, income, outgoings, existing commitments and credit history. Secured borrowing also depends on the property and available equity. Meeting basic criteria does not guarantee approval or an affordable rate.

How to apply for a debt consolidation loan

Nowadays you don’t have to visit your local bank to apply for a debt consolidation loan. You can submit an application using bank websites or you could use an online lender instead. 

Your application will require you to upload a range of documents to prove your identity and address, as well as prove your financial situation. You should organise this before starting to apply. 

Lenders carry out creditworthiness and affordability checks. Approval, the rate offered and the time taken depend on the lender, product and your circumstances.

Debt consolidation companies

A debt consolidation company may be a lender or a credit broker. Check its role, permissions, service and fees. A loan enquiry or comparison does not by itself provide debt advice about all available options.

The debt consolidation company might help you consolidate by providing you with a consolidation loan directly, or they might act as a broker to help you search and apply for a loan from a third party. 

Can you do debt consolidation without debt consolidation companies?

You don’t have to use a debt consolidation company to use a debt consolidation method. 

Scores of debtors decide to do debt consolidation without using a debt consolidation company.

You can approach lenders directly, but if you are struggling with repayments, seek free debt advice first. A debt adviser can help compare repayment and insolvency options as well as the risks of further borrowing.

How much does debt consolidation cost?

The cost of debt consolidation depends on a range of factors, including:

1. Early repayment charges
2. Balance transfer costs
3. The interest rate you’re offered
4. Whether you used a debt consolidation company or not

Debt Consolidation Calculator

A debt consolidation calculator can estimate payments and compare costs using the figures you enter. Include the full repayment term, interest and fees on both the new and existing debts. It is not a personal recommendation or a guarantee of the rate you will receive.

A calculator cannot decide whether borrowing is suitable or affordable for you. If you already have payment difficulties, get free debt advice before applying.

Does debt consolidation affect your credit score?

Debt consolidation might have an immediate negative impact on your credit score because you’ll be required to apply for more credit. 

A simpler repayment schedule may help with budgeting, but consolidation does not prevent missed payments or protect your credit score by itself. The effect depends on applications, borrowing levels and how you manage repayments.

Does consolidation build credit?

Keeping up with repayments and reducing debt may support your credit history over time. There is no guaranteed score improvement, and taking on unaffordable credit can make matters worse.

What’s the difference between debt consolidation and debt management plans?

A Debt Management Plan (DMP) is an alternative to taking a consolidation loan. It is an informal arrangement to repay eligible debts through a provider. Essential bills and excluded debts still need to be paid separately.

A DMP does not involve taking out a new loan. The provider distributes your payments to your existing creditors, reducing the balances over time. Interest and charges are not guaranteed to stop, fees may apply with some providers, and a DMP can affect your credit record.

What’s the difference between debt consolidation and debt settlement?

Debt consolidation and full-and-final settlement are different approaches.

Consolidation uses new borrowing to repay existing debts. With a full-and-final settlement, you ask a creditor to accept a lump sum below the balance owed and release you from the remainder. Creditors do not have to agree, and the settlement may affect your credit record.

Get debt advice and written confirmation of any settlement terms before making a payment. Do not take out a new loan on the assumption that creditors will accept reduced settlements.