There are many solutions for dealing with debt, so many – in fact – it’s possible to feel overwhelmed by the sheer number of choices available.
One of those you might have come across is debt consolidation. When it comes to what a consolidation loan is, though, there are many different opinions about how it all works.
Some believe that debt consolidation is the best way to regain control over your finances. Others wouldn’t dream of using one. As with all financial products though, whether this solution is right for you depends on your circumstances (and you should always speak to a financial expert before making a decision).
Here are some of the most enduring myths regarding debt consolidation.
- Myth 1: Debt consolidation reduces your debt
- Myth 2: If you have bad credit, you can’t apply
- Myth 3: You can get government debt consolidation
- Myth 4: Debt consolidation is bad for your credit score
- Myth 5: It’s a time consuming process
There are some solutions out there which write off large amounts of what you owe or reduces the size of your debts. This is not one of them. Broadly speaking, with a consolidation loan, you borrow an amount which is equal to – or exceeds – the total value of your debts. (So if you borrowed a small short term loan from someone like Little Loans, you’d still have to pay the full amount you borrowed.)
You then use this money to close accounts with your current lenders. By doing so, you’ll still owe the same amount of money, but you’ll have just one creditor (the consolidation loan provider) left to repay.
At this point, it’s reasonable to question the point of this debt solution. However, if you get a provider which ultimately charges less interest or requires smaller payments, you could have more money left over at the end of each month.
When applying for a loan, those with bad credit may be immediately turned away. Therefore, it’s fair to assume the same when it comes to this solution.
However, finding debt consolidation loans for bad credit isn’t impossible. Perhaps it’s because you’re ultimately transferring money from one account to the other, but many consolidation loan providers won’t immediately dismiss an application just because of a person’s credit history.
It’s worth bearing in mind that those with a poor credit history may only be applicable for secured debt consolidation (which means it’s more of a risk for you). Still, these people are unlikely to be refused outright just because of their financial past.
This is probably where consolidation loans sometimes get a bad reputation. Although some companies offer products using similar wording to ‘government debt consolidation’, this solution doesn’t actually exist.
There are debt solutions which are government-related though. These can include:
- IVAs (individual voluntary arrangements)
- Debt relief orders
If you find a company trying to sell you government debt consolidation, chances are, they are probably trying to mislead you.
In the short term, it’s true that debt consolidation will probably harm your credit score. After all, you’re taking out another line of credit which increases your credit utilisation ratio. However, in the long-run, this loan could end up being beneficial if you use it right. Here’s how:
- You pay off all your current lenders
- By making payments on time to the provider, you start building up a good repayment history
- Your credit utilisation ratio gradually starts to decline.
In fact, the only way debt consolidation could ultimately be bad for your credit score is if you missed repayments or defaulted on the loan.
Although closing accounts with all your current creditors can be a time-consuming process, once done the loan should make your life a bit easier to manage. You’ll only have one lender to repay, that means one interest rate to manage and one monthly payment to sort.
If anything, a debt consolidation loan could possibly free up time.
Is a debt consolidation loan helpful or harmful?
As with any financial product, whether a debt consolidation loan will be helpful or harmful to you depends on your circumstances. That’s why it’s essential to seek advice from a qualified debt advisor before choosing this solution – they should strive to make sure whatever you choose gives the best deal possible for you.
If you wouldn’t benefit from debt consolidation then, fortunately, there are other options which should be available to you.