Loans: Consolidating Debts

Personal loans aren't just used for buying big ticket items such as a car or a new kitchen. These days, it seems that you can hardly turn on the television without seeing endless adverts promising to "consolidate all your debt repayments into one easy, manageable monthly sum". These are usually aimed at people with a bad credit record.

A debt consolidation loan means you pay down one single debt, rather than trying to keep up with several smaller ones. Typically, the interest charged on the combined loan should be lower than you would have paid on your previous debts. It can be scary to see how much all your loans amount to when grouped together, but ignoring problem debts just makes your situation worse. As with most financial decisions, consolidating your debts boils down to whether you can get a reasonable deal, taking all the charges into account.

However, most consolidation loans are arranged over long periods, in order to keep the monthly repayments down. Alas, the longer the term of your loan, the more you pay back, so this means an even bigger interest bill in the long run! This is the principal reason why the monthly repayments appear so much lower. But paying off your debt very gradually is rarely to your advantage. It may be easier to meet the monthly repayments, but it will end up costing you a packet in the long run!

Many lenders target what they call 'sub-prime' or 'credit-impaired' borrowers. These people, who represent about a quarter of UK adults, find it difficult to get a loan from a major high-street lender, usually because they don't have a good credit record.

Very often, these loans will be secured on your property, yet you still pay a high rate of interest - with the added risk of losing your home if you fail to make the repayments.

Another problem is that the rate is often variable, so you can't be sure that it's going to remain the same throughout the life of your loan. Can you be sure that they won't whack up the rate in your second year, or if you're late with a repayment?

You also need to be careful of illustrations such as '£15,000 over sixty months @ £322 a month' when sixty months is, er, five years. They describe loan terms in months rather than years because it sounds so much shorter and, frankly, it's devious.

Many people also assume that once they have bundled their existing debts into one package, they have somehow drawn a line under them and 'cleared' them. Nothing could be further from the truth! Sadly, a high proportion of people who take out consolidation loans then go on to run up further debts before they've cleared the first batch. Although it's tempting to go off and start spending on that newly cleared credit card again, it's the worst thing that you could do in this situation, because it merely adds to your problems. It's estimated that the majority of people who take out a consolidation loan actually end up further in debt. Don't make this mistake!

To get some practical views from people who have battled their debt burden and won, visit our Dealing With Debt board.

Next article: Choosing The Right Loan

Published on November 17, 2006