What is debt consolidation and what are the types of debt consolidation that people use? These are two big questions we will be answering here. Our answers have been broken down to make understanding the different types of debt consolidation easy.
What Is Debt Consolidation?
Debt consolidation is a debt mitigation strategy that consolidates your existing debts into fewer debts. For example, you might take out credit to pay off three other debts so you now have a single debt. However, it is done to be financially advantageous. The new single debt should have a lower interest rate than the interest you were paying on the other debts, and/or it should provide a repayment holiday to help you save.
Can Anyone Try Debt Consolidation?
Everyone can try to get more credit to consolidate their debts, but it is not guaranteed to work. Because you are trying to borrow more, some creditors may not provide credit because of your existing debts.
Debt consolidation can be a clever option, but it is not always possible.
The Types of Debt Consolidation
Debt consolidation comes in different forms. The three most popular methods of consolidating debt for financial gain are:
- Debt consolidation loans
- Debt consolidation credit cards
- Remortgaging as debt consolidation
Debt Consolidation Loans
A debt consolidation loan is when a debtor takes out a new loan to repay their existing debts. For example, you might have two debts of £500 and take out a new loan of £1,000. You then use this new money to pay off the other debts. You now have one debt instead of two.
But reducing the number of debts is only really beneficial if you can simultaneously reduce the amount of interest you pay and/or your loan repayments. If you were paying 10% interest on both of the other loans and you are paying 7% interest on the new loan, you will have reduced interest by 3%. Some loan providers might even give you a repayment holiday in the beginning, giving you a chance to save some more for future repayments.
Make sure you understand the full terms and conditions of the new loan and any fees you will pay as this will determine if it worth it.
Secured Vs Unsecured Consolidation Loans
An unsecured loan is a loan where you do not risk assets. For example, if you don’t pay it back you will not lose your car or home. A secured consolidation loan is different because you could lose assets by not paying it back. An example of the latter would be remortgaging for debt consolidation, which we discuss later.
Debt Consolidation Credit Cards
Debt consolidation for credit cards is also known as credit card balance transfers. This is when you transfer the money owed from one or more credit cards to a new card you take out. Not all credit cards accept balance transfers so you need to be careful before making an application.
The idea is that by swapping your existing credit card debt to a new credit card with lower interest, you can save money on your repayments.
But sometimes debtors choose to do a credit card balance transfer for other reasons. Many credit card companies offer a 0% interest offer or repayment holiday in the first few months. This can be a way to save up to make repayment easier and make the debt more manageable.
What to Watch Out for?
Along with the aforementioned pitfall of taking out a credit card that does not allow balance transfers, you also need to watch out for balance transfer fees. There might be none to pay or you may have to pay a percentage of the balance you bring over, usually around 3%. In this instance, if you transferred a debt of £2,000, you would have to pay a fee of £60 to do the transfer.
Remortgaging to Consolidate Debt
Remortgaging is most often associated with getting a new mortgage with a better rate of interest or to access capital for home improvements. But it is also possible to remortgage to consolidate debts.
If you have debts from loans and credit cards, you could choose to remortgage your property and access cash to pay them off. You will then be paying off these debts through your new mortgage, which may provide a better interest rate or other advantageous repayment terms.
Unlike the former two types of debt consolidation, remortgaging to pay off debt is applicable in niche circumstances. It comes with a lot of considerations and potential pitfalls, and professional help will be needed.
Who Can Help with Remortgaging for Debt Consolidation?
Specialised mortgage advisors are the best people to go to if you are considering remortgaging for this reason. They will be able to assess the situation and tell you whether you can benefit from remortgaging for this purpose.
Alternative Debt Solutions
If remortgaging is not recommended and you are struggling to get credit – loans or credit cards – to consolidate your debts, other debt solutions are available. You don’t have to consolidate debts to make them easier to pay back.
Other debt solutions include:
- Debt Management Plans (DMPs)
- Debt Relief Orders (DROs)
- Individual Voluntary Arrangements (IVAs)
An Individual Voluntary Arrangement is an excellent debt solution for people with debts above £15,000 (approx.). It not only consolidates your debt into one monthly repayment which is then shared by all your creditors, but at the end of its term you can wipe off as much as 85% of all money owed.
For more information on IVAs, check out our latest guide on IVAs in 2020 and beyond!
Is Debt Consolidation the Right Decision?
Everyone has different debtor circumstances and the only way to know if it is right for you is to do detailed research. For help with this, why not speak to a debt charity and get free debt advice?