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4 mistakes to avoid when consolidating debt

4 mistakes to avoid when consolidating debt

By: Diana Bocco | 12th June 2020

Debt relief can provide a fresh start, helping you simplify the debt repayment process. Before you jump into it, however, it’s important to be aware of mistakes to avoid when consolidating debt. After all, obtaining a debt consolidation loan is only one of the many possible steps to achieve financial freedom.

Here’s a roundup of some common debt consolidation mistakes to watch out for:

1. Taking out a new loan at a higher rate

Debt consolidation involves taking out a new loan to pay off all of your existing debts. But the goal of debt consolidation is not just to get rid of your old credit card and loan debts. It’s also to end up with a lower interest rate than you were paying before.

If you have a really poor credit rating, obtaining a loan with a low interest rate can be difficult. This is an important point to discuss with the debt consolidation company you’re using. They should be able to help you search for the best market interest rates.

2. You don’t have a budget

One of the biggest mistakes to avoid when consolidating debt is ignoring how you got into trouble in the first place. Creating a budget will help you understand your money better so that you make smarter spending decisions in the future.

Designing a budget doesn’t have to be complicated. Just write down your expenses for the month, including not only your mortgage (or rent) and utilities, but also groceries and extras such as gym membership or monthly subscriptions. If the final number is higher than your income (or too close for comfort), you need to rethink your budget. Ideally, your budget should have a small buffer.

A buffer or ‘budget surplus’ is basically what you have left after paying off all your expenses – a small cushion of a few hundred pounds that you keep in your bank account “just in case”. Buffers can cover unexpected expenses and those little emergencies that might pop up – such as urgent home repairs – so you don’t have to go into debt again to pay for them.

3. Not doing your homework

When it comes to consolidating your debts, there’s no one-size-fits-all. Different companies will offer different options, so one of the biggest debt consolidation mistakes you can make is to say yes before looking at what else is out there. 

Being extra careful will also keep scammers away. According to the Financial Conduct Authority, common signs of a scam include being contacted out of the blue and being pressured to sign an agreement. Any genuine debt consolidation company will allow you time to think about your options and won’t rush you into a decision.

It is also important to be sceptical about any debt consolidation promise that seems too good to be true. No company can solve all of your financial woes through consolidation, especially before sitting down with you to review your situation.  

4. Taking a loan that takes too long to repay

While it might seem like a good idea to take a loan with a long repayment timeline, this could bring additional problems. Sure, your monthly payments will be lower if you agree to pay back the new loan over a five-year term. But you will also end up paying back much more in interest than if you choose a two-year term.

The ideal solution is to pick a loan with the shortest repayment term you can afford. This means considering not only the size of the monthly repayments but also the interest rate of the loan and the total amount you’ll have to repay. When in doubt, sit down and discuss your options with a debt counsellor before making any binding decisions.

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