Used properly, a debt consolidation loan can be an effective way to take control of your finances, paying off your debts faster and saving money in the process.
They’re less complicated than they seem - and in this article, we’ll cover:
How debt consolidation loans work,
When to use one (and when they should be avoided),
What to look for when choosing a debt consolidation loan if you have a low credit score, and
What alternatives you might also want to consider.
We’ll keep things simple and straightforward, cutting through the usual jargon and complex terms.
Before we start, if you already know that a debt consolidation loan is right for you, you might want to skip ahead and look at providers.
For example, Koyo uses Open Banking technology, so that we can base our lending decisions on your real financial situation - rather than just what someone else says about you. Find out more at www.koyoloans.com (representative APR 27%).
Otherwise, read on!
What is a debt consolidation loan?
A debt consolidation loan is best illustrated through an example. Imagine you owe money on three credit cards:
£1,000 on a card charging 20%
£1,000 on a card charging 30%
£1,000 on a card charging 40%
In this example, you owe £3,000 and are paying an average interest rate of 30%. You have three key challenges:
You’re paying a relatively high rate of interest,
You’re juggling three different monthly repayments, and
You might be tempted to just make the minimum payments each month, rolling over debt indefinitely.
Life would be much simpler if you were able to take out a single loan to pay off your credit cards. And, if that loan had an interest rate below 30%, you’d save money, too. Lastly, a personal loan is paid off over an agreed period, so as long as you stick to your planned repayments, you’d be debt-free faster than if you’d just made minimum monthly payments.
That’s what a debt consolidation loan does. You take out a personal loan and use it to pay off all your existing debts. Ideally, you’ll also end up paying a lower rate of interest.
So, a debt consolidation loan isn’t a special product - it’s simply a personal loan that you use to pay off other, more expensive types of debt, such as credit cards, store cards and overdrafts. More on this at debt consolidation vs personal loans.
What to watch out for
There are two things to keep in mind here. Firstly, you should only borrow what you can afford to repay, and you should stick to your repayments. A debt consolidation loan alone won’t solve all your problems - you’ll also need to make sure you don’t go back into debt, by adapting your spending.
Secondly, a debt consolidation loan may prove more expensive if you end up taking more time to repay your debts - even with a lower interest rate. Paying back £1,000 at 30% APR in one year is cheaper than paying back £1,000 at 20% APR in two years - so make sure you factor in the total cost of repayments over the full loan term, rather than focusing on the headline rate.
There are also different types of personal loan that can be used for debt consolidation. Here are some of the key distinctions:
Secured vs. unsecured loans
A secured loan is a loan backed by an asset - usually your home. That means your home is at risk if you fail to make repayments in full and on time. Naturally, a secured loan is something available only to homeowners.
By contrast, an unsecured debt consolidation loan doesn’t have this backing.
Because of this, an unsecured loan is much safer for you, the borrower, and in general, you should avoid secured personal loans if you can help it.
Secured loans do have some advantages though: because the lender knows it can repossess your house if you don’t repay, it may be willing to lend a larger amount or at a lower rate. That doesn’t change the advice above though - you should generally avoid taking on additional secured debt if you can.
Usually, if you fail to repay a loan, you’re the one that’s on the hook.
Guarantor loans work slightly differently: a third party (usually a close family member) “guarantees” the loan, by agreeing to step in if you fail to make full repayments.
That’s the fundamental difference between a guarantor loan and a personal loan, but guarantor loans also tend to charge a high interest rate.
If a guarantor loan is your only option (i.e. if you’re unable to access a conventional loan) and you’re lucky enough to have someone willing to guarantee the loan for you, it can be an option worth considering, but for most people, a conventional personal loan will be a better option.
Can you get a debt consolidation loan with a low credit score?
Yes - borrowers with a less than perfect credit history will still be able to access debt consolidation loans. The lower you go down the scale, the fewer options you’ll have though, and those options will be more expensive and have lower maximum loan amounts.
We’ve put together a specific guide for people with “fair” credit scores, and the same principles apply to borrowers with scores lower than that.
If your score is extremely low though (for example in the “very poor” category), it’s likely that you won’t be able to borrow, or will face extremely high rates of interest. If that’s the case, you might want to look at other options - debt charity Step Change is a good place to start.
Lastly, if you’re worried about the effect applying for too many loans might have on your credit score, you can use an eligibility calculator to get an idea of whether you’re likely to be approved for a given loan before you apply.
Can you get a debt consolidation loan without a credit check?
No - all mainstream lenders will carry out a credit check before writing any kind of loan.
However, not all credit checks are equal. For example, there are three credit reference agencies (CRAs) in the UK, each of whom uses slightly different criteria when assigning a score. So a lender who uses one credit agency might give you a different decision than a lender who uses another credit agency.
Some lenders rely less heavily on credit scores since your credit history only provides part of the picture. For example, lenders such as Koyo use Open Banking technology to securely view your bank account information. Using this information, Koyo can see your outgoings and expenditure, providing a realistic picture of how affordable a given loan is for you.
This means they’re able to rely more on your real financial position, and less on what someone else says about you.
Does a debt consolidation loan affect your credit score?
Yes - but perhaps not in the way you think.
In general, taking on new credit will reduce your credit score, and that’s true of debt consolidation loans too - at least in the short term.
However, a good debt consolidation loan, used properly, will help you to reduce your debt over the long term - and the surest way to increase your credit score is to pay off existing debts.
So while you’re likely to see a dip in the short term, so long as you’re responsible and are able to stick to your plan, you’ll increase your credit score.
What other ways are there to consolidate credit card debt?
As well as consolidating debt with a personal loan, it’s also possible to consolidate debts using a balance transfer credit card.
This gives you a new credit card which you can use to pay off all your existing ones, ideally at a lower rate. Some balance transfer credit cards even come with a 0% introductory period, so if you can pay off the balance during that period, you might save money.
A word of warning though: rates shoot up after that introductory period, and you’ll also face a fee (calculated as a percentage of the amount you’re borrowing).
One final drawback is that a balance transfer credit card doesn’t have fixed loan repayments. In one way that’s good - it gives you added flexibility - but you’ll also need more self-discipline in order to pay it off.
Want to know more? Should you take out a loan to consolidate credit card debt
How can you improve your credit score?
Good question! The truth is that credit scores are complex, and the credit reference agencies - Experian, TransUnion and Equifax - don’t reveal exactly how they’re calculated.
However, they do offer information for would-be borrowers on how to improve your credit score.
The link above has more detailed information, but some of the most important steps to take are:
Making sure that you repay all debts on time,
Registering on the electoral roll,
Not using all of your available credit (e.g. by not maxing out your credit card),
Checking for mistakes on your file and
Keeping accounts open (and in credit), to show stability.
Each of the three credit reference agencies allows you to check your credit score for free, and you can use this as a chance to check for errors and fraudulent activity and see what might be holding you back.
Improving your credit score can take time, but it’s worth it - a good credit score will help you to access credit more easily in future, and to borrow at a lower rate of interest.
Hopefully, you’ve found this article useful. To summarise:
Debt consolidation loans can be an effective way to reduce the total amount of interest you repay and get you out of debt faster.
However, there are other ways to achieve the same goal - depending on your circumstances, you might find a balance transfer credit card to be a better option.
There are a range of lenders who offer loans for debt consolidation, so there’s a lot of choice out there, even if you have a low credit score.
If you think a debt consolidation loan could be right for you, Koyo uses Open Banking technology, so that we can base our lending decisions on your real financial situation - rather than just what someone else says about you. Find out more and use our loan calculator at www.koyoloans.com (representative APR 27%).
We’ve added some FAQs below, but if there’s anything else you’d like to know, it’s worth taking a look at our more detailed guides:
Frequently asked questions about getting a low credit score debt consolidation loan
How can I consolidate my debt with a bad credit score?
A low credit score makes borrowing harder: you’ll have fewer options available to you, and will usually have to pay a higher interest rate.
However, a poor credit score doesn’t make it impossible - for most borrowers, there will still be options available. An eligibility calculator is a good place to start if you’re worried about your loan application being rejected.