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Debt consolidation

A debt consolidation loan can be a simple, effective way to simplify your existing borrowing and save money in the process.

This is our ultimate guide to debt consolidation loans in the UK. We’ll cover everything you need to know, including what they are, how to get one, and how it affects your credit. 

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What is a debt consolidation loan?

A debt consolidation loan is a way to bring together multiple forms of credit, into a single loan. When it’s done effectively, it can help you:

  • Simplify your borrowing
  • Save you money

a worked example showing how a debt consolidation loan could save you money

To find out how, let’s look at an example. Imagine that you have three credit cards, with £1,000 outstanding on each one. Unless you’re paying them off in full each month, you might be paying quite a high rate of interest.

In a case like this, consolidating credit card debt could help. Here’s how it works:

  1. You work out exactly how much you owe, across all your credit cards (in this case, £3,000)
  2. You take out a new loan for that amount – ideally one with a lower interest rate than your existing borrowing
  3. You use that loan to pay off your credit cards
  4. You make the monthly payments on the loan until it’s paid off – generally via a simple direct debit from your bank account

Now you only have one monthly payment to manage – and if your new loan is at a lower rate, you’ll usually save money on the interest payments too, resulting in a lower total amount to pay off.

Want to know more about the detail? Take a look at our guide to how a debt consolidation loan works.

What’s the difference between a debt consolidation loan and a personal loan?

Not much, actually. In fact, a debt consolidation loan is just a type of personal loan – and has all the associated perks: they’re usually at a fixed rate of interest (unlike, say, a tracker mortgage), paid off over a specific term and often with the flexibility to repay early if you want to.

However, not all lenders offer debt consolidation loans, and will ask you what you plan to use the money for during the application process. It’s important that you answer all questions from a lender honestly.

What are the alternatives to using a loan to consolidate debt?

The main alternative is what’s known in the UK as a balance transfer card. Instead of taking out a new loan and using that to pay off your existing loans, store cards and credit cards, you move the balance onto a new credit card – ideally one with a low rate of interest.

For borrowers with a good credit rating, this can often be attractive: some providers offer long interest-free periods. However, there’s usually a fee payable up front (often a percentage of the amount you’re transferring), so you need to be sure that this fee doesn’t cancel out the saving you’d otherwise be making.

Both options can work well, so it’s important to do your research – it’s worth working through a representative example, and your eligibility (the options available to you) might vary depending on your financial situation and credit history. You can use a free online loan calculator to evaluate different options and make sure you can still comfortably afford your outgoings.

It’s also worth noting that there are two types of debt consolidation loan: secured and unsecured. Secured loans (also known as homeowner loans) are secured against your home, meaning that your home is at risk if you fail to make your repayments. They’re riskier, but can be used to borrow larger amounts of money and may be available to borrowers with lower credit scores.

Unsecured debt consolidation loans aren’t linked to your home, meaning that they’re safer for borrowers. The Money Advice Service recommends that you get free advice if you’re considering a secured loan.

How can a debt consolidation loan lower my monthly payments?

Let’s take another look at the example above:

Amount outstanding Interest rate
Credit card 1    £1,000 30%
Credit card 2    £1,000 35%
Store card 3    £1,000 40%

In this example – which is simplified in order to illustrate the point – the amount repayable is £3,000, and the borrower is paying an average interest rate of 35%. So, if you can borrow £3,000 at less than 35% via a personal loan to consolidate debt, and use that money to pay off all three credit cards, you should save money.

But there’s one important thing to be aware of: this saving can disappear very quickly if you extend the borrowing period. Borrow £100 for a year at 10% and you’ll pay £10 in interest. Borrow the same amount for two years at 7% and your loan repayments would add up to £14.

So, the important lesson is that you should pay debt off as quickly as you can afford to, which means trying to avoid extending your loan term or paying it off over a longer period. That way, you’ll minimise the total amount that you have to repay. 

Which types of debt can I consolidate?

Debt consolidation loans are pretty flexible, and you can use them for lots of forms of borrowing. That includes:

  • Credit cards
  • Store cards
  • Personal loans
  • Home improvement loans
  • Current account overdrafts
  • Payday loans

However, that doesn’t mean that it’s right for every set of personal circumstances. If you’re considering any type of debt consolidation, you should ask yourself:

  • Will I save money over the long term?
  • Am I confident I can make the monthly repayments over the full life of the loan?
  • Do the savings I’d make exceed any fees I’d have to pay?

If the answer to any of these questions is “no”, it’s a good idea to seek some advice. Step Change is a great place to start.

If you’re answering yes though, we’ve got more information in a thorough guide to when debt consolidation is a good idea.

Will a debt consolidation loan affect my credit score?

Yes, but perhaps not in the way you’d expect. Although it might take a short term dip, steadily paying off debt is one of the best things you can do for your credit score. So, if a debt consolidation loan helps you get in control of your finances and you pay it off in full and on time, you should get a boost.

Want to know more? We’ve got a full guide to how debt consolidation could affect your credit score.

How can I get the best deal on a debt consolidation loan?

Probably the most important thing to do is to shop around. A comparison site is a good place to start – if you put your details in, a good comparison site will show you personalised quotes with representative APRs (annual percentage rates) for your loan amount and the key information for each offer.

It’s also worth going direct to a few providers – not every company is listed on comparison sites.

Because many lenders base the rates they offer you (and the amount they’re willing to lend) on your credit history, it’s worth making sure that your credit file is as good as it can be. Money Saving Expert has a useful guide to boosting your score, and while it’s generally something that takes time, there are a few tips which might give you a quick increase.

It’s not all about credit scores though, and if you’re a responsible borrower but don’t yet have a good credit score (for example because you’re a first time borrower, or new to the UK), you might want to consider an Open Banking lender

Rather than rely on what credit agencies say about you, some new lenders use Open Banking technology to get an accurate picture of your finances. That way, they can get an up to date view of how affordable a loan is for you, without needing to base their decision solely on your previous credit history.

Interested? If so, the next step is to take a look at our article on how to get a debt consolidation loan – you’ll find practical advice and a detailed guide to help you get the best results.