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Consolidation loans – not always enough on their own...

06/08/2008

Why take out a consolidation loan? As anyone struggling with multiple debts can tell you, simply keeping track of them all can be one of the biggest challenges. Missing a single payment can incur penalty charges and damage your credit rating.

The right consolidation loan will, of course, also reduce your monthly payments and hopefully the interest rate you’re paying. So a consolidation loan can make a big difference to your situation – but in itself, it’s not always enough…

After you’ve taken out a consolidation loan
If you do take out a consolidation loan, your debt won’t be gone. It may be a lot more manageable than it used to be, but you’ll still need to make regular monthly payments – and make them for longer, if you’ve arranged to repay the consolidation loan more slowly than the original debts. And since you’ll be paying interest for longer, repaying slowly might end up costing you more.

You’ll also need to resist a few temptations.

You’ll need to resist the urge to use any credit / store cards and overdrafts which you’ve paid off. This is one danger of consolidation loans – all your lines of ‘easy access’ credit suddenly become available, and it’s all too easy to start using them whenever you need a small amount of cash. Before long, these debts can reach dangerous levels again, leaving you in a worse position than you were in before you consolidated your debts in the first place, as you’ll have to pay off your new debts and your consolidation loan. That’s why many people cut up their cards and cancel their overdraft facility the moment they take out a consolidation loan.

Then there’s the temptation to take out new credit. The thought of paying off one big consolidation loan can be a lot less intimidating than paying off multiple smaller loans, even if the amount owed is exactly the same. So if you’ve just paid off multiple debts with a consolidation loan, the important thing is to remember the actual amount you still owe, rather than thinking “I only have one debt”.

Third, there’s the temptation to fall back into your old habits as soon as the consolidation loan is paid off. Even though the consolidation loan successfully got you out of debt, the best solution to debt is to try not to borrow in the first place!

Consolidation loans – always the right solution?
Finally, remember that a debt consolidation loan isn’t necessarily the right debt solution for you.

• If, for example, you’d rather avoid any further borrowing at all, you may prefer a debt management plan, which involves asking a debt expert to reduce your monthly payments by re-negotiating your payments with your creditors.
• If…
  • your debts are substantial (around £15,000 or more), and
  • you can’t afford to make your monthly payments, but
  • you can commit yourself to making regular fixed payments,
  …then an IVA (Individual Voluntary Arrangement) might be more appropriate than a consolidation loan. It’s a government-backed debt solution in which you spend five years (in most cases) paying as much as you can afford once you’ve taken essential living expenses into account. An IVA can’t go ahead unless creditors accounting for at least 75% of your debt agree. If they do, they’ll commit to writing off any outstanding debt when the IVA is successfully concluded.

These aren’t the only other debt solutions available, but they’re important alternatives to a debt consolidation loan – and a professional debt adviser can help you understand all the pros and cons, so you can choose the solution that’s best for you.

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