How Do Debt Consolidation Loans Work?

Debt can be impossible to manage, on average people have 4 to 5 debts at one time to make monthly payments on. 

The consequences of not repaying your monthly repayments of your outstanding debts can be dangerous and have bad consequences, such as added interest or a negative effect on your credit score. 

You may look to borrow money online to help you pay off this debt. Debt consolidation loans gives you the chance to consolidate these debts into one, making it much easier to manage and allows you to concentrate on making repayments. 

This guide takes you through what debt consolidation loans are, whether they affect your credit rating, what you can use a debt consolidation loan for and what the benefits of a debt consolidation loan are.

What is a Debt Consolidation Loan?

A debt consolidation loan is a personal loan that consolidate multiple loans into one fixed monthly payment. Debt consolidation loans will generally have terms between 1 to 10 years and you may be able to borrow up to £60,000 depending on your credit rating.

Lenders will not specifiy how you use the money you borrow from the loan so it is up to the borrower on how they will split the money between their debts. The idea, if possible, is to split up the money so that you pay off all outstanding debts.

This will leave you with one last debt, this debt consolidation loan to pay back monthly. This will help you manage your debts better and make sure you are making all your repayments. This can also help you boost your credit score if you have a bad credit rating.

You will want to focus on the debts with the highest interest rates first as they are the most expense. Make sure that the interest rate for your debt consolidation loan is lower than the interest rate of previous loans and debts.

Does A Debt Consolidation Loan Raise Your Credit Score?

Yes, there are certainly situations where debt consolidation can raise and boost your credit score. 

One way in which debt consolidation loans can help raise your credit score is by making on-time monthly repayments. 

When you have a debt consolidation loan it makes it much easier for you to organise your finances, this means that you will be more likely to make your monthly repayments. 

Without monthly repayments coming out of different accounts all of the time, you can keep track of your debt much better and make sure you make your monthly repayments. 

When you make these repayments you will boost your credit score as making repayments on time raises your score. 

This is because lenders can see that you are a trustworthy lender and can make repayments on time.

Having a debt consolidation loan can also help raise your credit score by giving you a lower credit utilisation. 

When you transfer your credit card debt to a balance transfer card with a higher credit limit, the resulting lower utilisation rate can help improve your credit score. 

The same will be applied if you use your debt consolidation loan to do debt management and pay off a credit card debt because that will bring your utilisation rate down to 0. 

What can I use a debt consolidation loan for?

A debt consolidation, as is in the name, is a loan that is used to pay off different types of debt to make sure that you only have one loan left to repay. 

The different types of debt that you will be able to use your debt consolidation for include, but are not exclusive to: 

• Credit Card Debt – Credit Cards charge extremely high APRs which means that they are an extremely expensive way to borrow for the long-term and therefore a debt consolidation loan can be used to pay off your credit card debt in one go. 
• Personal Loan Debt – An unsecured personal loan, that was used to fund a car purchase or a holiday might be building up interest and you can pay it off early using a debt consolidation loan.
• Bank Account Overdraft – Most high-street banks will charge extremely high interest rates on overdrafts in your bank account. Over time this can lead to huge debt and a debt consolidation loan might be the best way to avoid this. 
• Store Card – Some store cards will offer discounts but they also often have high fees and APRs and paying off a store card will help you consolidate your debt more efficiently. 

What are the benefits of a debt consolidation loan? 

There are many benefits to a debt consolidation loan, allowing yourself to have less accumulated debt will help you organise your debt in a more structured and healthy way. 

Some of the benefits of taking out a debt consolidation loan are:

• Reduce monthly payments – If you have a few loans out at the same time and they are all incurring interest then paying them off will allow your monthly payments to reduce to just the one debt consolidation loan. Moreover, debt consolidation are loans are unsecured loans so you do not have to worry about an asset of yours being repossessed.
• Lower overall interest – Debt consolidation loans tend to often have a much lower interest rate or APR than payday loans or other types of credit cards and therefore can help you pay less interest in the long run.
• Easier to keep track of debt – One of the main selling points of a debt consolidation loan is that it allows you to keep track of your debt in a much better way. It is much easier to pay off one debt a month rather than keeping track of many different repayments out of many different accounts.
• Boost your credit score – Paying off other loans will help to boost your credit score and now you only have 1 monthly repayment to make, you can be in control of your debt and this allows you to boost your credit score by not missing repayments.