Posted in: Tips

How debt consolidation works

Turns multiple debts into one manageable monthly payment

It can be difficult to keep track of your finances when several different payments leave your account every month. A debt consolidation loan enables you to completely repay multiple existing debts – effectively rolling them into one new loan – which can make dealing with your debts a lot simpler.

Reduces your debt repayments

Your new loan could also help you to reduce the amount you pay each month. For example, repaying a debt consolidation loan over five years should cost you much less per month than repaying your existing debts over three years.

The longer the repayment period, the smaller your new monthly payment will be – but remember that this also means you’ll be paying interest for longer, and you could pay more overall as a result.

Could reduce the interest rate you pay

If your debt consolidation loan has a lower interest rate than the debts you’re paying off, the amount of interest you pay could be reduced (and that means lower monthly payments). This could be especially helpful for reducing the cost of high-interest debts, such as credit cards.

Just keep in mind that if you decide to repay your new loan over a longer period of time than your original debts, you may still end up paying more interest in the long run.

debt consolidation

Simplifying your finances

A debt consolidation loan could simplify your finances by letting you repay all your existing debts in one go, leaving you making a single monthly payment to a single lender.

  • You’d be less likely to make your payments late – or forget them altogether – which means you’d be less likely to be charged or damage your credit rating (something which can really add to the cost of getting credit in the future).
  • And since you’d be making just one payment per month, budgeting should be a lot easier, as you’d know exactly how much money to set aside for it.
  • You’d also save yourself the hassle that goes with making multiple payments, checking statements, and figuring out how much debt is left, how long it’ll take you to clear it, and so on.

Reducing your monthly costs

Debt consolidation gives you a valuable opportunity to reassess your situation and really plan your finances. It’s a chance to start over with a single larger debt, rather than multiple smaller debts.

This time, when you arrange your repayment terms, you’ll already know how much you can comfortably afford to pay every month without taking up every penny of your available income.

A note about debt consolidation

If you’re thinking about debt consolidation, it’s important to recognise that repaying any debt more slowly will delay the day you’re debt free.

And unless the interest rate on your debt consolidation loan is significantly lower than on your previous debts, you might end up paying more in interest overall, as your interest will have more time to grow.

Having said that, most people who consolidate their debts figure that’s a price worth paying if it means they can bring their monthly payments down to an affordable level.

Finally, remember that securing any debt against your home should only be considered if you’re completely sure you can afford your repayments. Failing to repay a secured debt could result in the repossession of your home.

How quickly should I repay?

If your repayment period is:

  • Too long, you’ll pay less each month – but you’ll pay more than you need to in interest.
  • Too short, you’ll pay less in interest – but your monthly payments might be uncomfortably high.

In most cases, the best way forward is based on a compromise – basically, you need to arrange a repayment period which is as short as possible, but which you’re sure you’ll be able to keep up with.