Is Consolidating Debt a Good Idea? The Pros and Cons
9th January 2023
In recent years, debt consolidation has become a popular method of debt management, seen by many as the best way to pay off multiple current debts. But since there can seem to be just as many benefits as there are drawbacks to this, is debt consolidation a good idea?
Whether or not consolidating your debt is a good idea for you is based solely on your own personal financial situation. If you have a good credit score, it might be a good idea for you. Whereas, if you have bad credit, it might be worth weighing up the pros and cons.
What is Debt Consolidation?
The concept of debt consolidation is a simple, but rather useful, one: take out a single loan to pay off multiple debts you have. In effect, this combines two or more of your existing debts into one larger one, usually with a lower interest rate. Now, this means you owe money to only one lender, where you previously owed many.
The way debt consolidation works is simple. Imagine that you owed £1,200 on a car you’ve financed, £2,000 on credit cards, and £1,500 on a student loan. All three debts would have different rates; your car loan could be 10%, whilst your credit cards could be 40% and your student debt could be 5%.
By taking a debt consolidation loan for the combined amount of your three debts (in this case £4,700), you can pay them all off immediately and instead of you owing three different entities money at different rates, you only owe one lender with one interest rate.
A debt consolidation loan is a type of personal loan and can be either an unsecured or secured loan.
A debt consolidation loan is inherently different from a Debt Management Plan (DMP) set up between you and your creditors, usually done with the help of debt charities or similar organisations that give out free advice for those in financial difficulties.
Pros of Debt Consolidation
One of the most common criticisms of the whole debt consolidation loan method is that many lenders charge fees for their loans.
Some do this upfront as a so-called “balance transfer fee,” “arrangement fee" or even cleverly disguised as "closing costs", whilst others do it later on down the line, calling them "annual fees".
At Finio Loans, however, we have no additional fees. This means we'll never ask you to pay a fee to get or maintain your debt consolidation loan with us, so you'll always know how much you’re paying each month.
Streamline Your Finances
By taking a debt consolidation loan out, you no longer have to worry about making multiple payments to different institutions on different days. Where you previously had multiple repayment days to remember, you now only have one.
This means no more missing payments because you completely forgot or making late payments with fees because you were short and forgot to move the money across. Aside from reducing your stress levels, streamlining your finances makes other things, like budgeting, much easier, further reducing your stress levels.
Cons of Debt Consolidation
Higher Interest Rates
So you remember earlier when we said that you could end up paying a lower interest rate? Well, that works both ways. Whilst you could get a lower interest rate, you could just as easily get a higher one.
The main reason behind this is your credit score. If your credit score is poor, you could see the overall interest rate you pay jump considerably.
What this means for your wallet is that you could see your overall monthly repayments increase.
Pay More Over Time
As a result of this, you might try to lower your monthly payments by selecting a longer repayment term, allowing you to pay back the money over a longer period.
Whilst this will mean you have a lower monthly payment, you’ll end up paying more in the long term due to compound interest, something Albert Einstein once described as being the “eighth wonder of the world”.
It Won’t Fix Your Problems
Despite what some articles on the internet might lead you to believe, consolidating your debt isn’t going to fix your financial problems overnight. It might not even fix them in the long term either.
If you have a history of living beyond your means, regularly use your credit card or even just go into debt to pay your monthly bills, you could consolidate your debts and pay them off, only to return to square one by accruing more debt.
If this is the root cause of your problems, doing other things, like making an effective budget (that you stick to!) and starting to build a financial safety net, are good first steps.
Does Debt Consolidation Affect Your Credit Rating?
Yes, if you get a debt consolidation loan, it will affect your credit report either positively or negatively for two reasons.
The first is that when you apply for a new loan, lenders like Finio Loans will run a credit check. If you actually apply for a loan as opposed to seeing if you are eligible, a record of the search stays on your credit report for five years. Running multiple credit checks may affect your overall credit score negatively.
However, if you see your loan term through to the end and can pay off your debt on time and in full, you should see your credit score increase as you've both got fewer outstanding debts and have have shown to other (potential) creditors you can pay a loan off.
Will Consolidating my Debt Save me Money?
Whether or not you'll save money by consolidating debt is purely down to your own personal circumstances, credit score and other credit commitments. As a general rule, however, if your credit score is good enough, you'll likely be able to access a lower rate, meaning lower loan payments, which will save you money every month.
You can see if you could save money by consolidating your debt with Finio Loans is by using Finio Loans’ eligibility checker. All you have to do is answer a few questions about yourself and select the amount you want to borrow. The checker will then see if you’re eligible and confirm the interest rate you would be eligible for. Best of all? Checking won’t affect your credit score!
All in all, consolidating your debt is a good idea for some people as it can takes the pain out of paying multiple creditors,. However it depends on the rate you are paying to your existing creditors, the rate you are offered and the term of the loan.
If you have a poor credit history, it may not necessarily be the best idea for you due to the risk of you paying more in monthly repayments than you are currently and could harm your personal financial situation more if you fall on hard times.
If you're considering a debt consolidation loan, Finio Loans is one of the UK's leading lenders when it comes to debt consolidation loans, so why not check us out?!