Can consolidating debts work?
There are some advantages to consolidating your debts into one consolidation loan. For many people it is enticing to have to make just one monthly payment instead of many. Making multiple payments to a variety of creditors in respect of a number of different accounts is time consuming, particularly when funds are tight and there is not enough money to go around. You have to decide which debts are ‘priority’ ones. These you must pay. For the rest you simply have to make do with whatever you can afford to pay, even if in some cases it is less than the contractual amount that you should be paying.
One big advantage – whether perceived or actual – is that you have just one creditor to deal with rather than many creditors. Managing your finances and payments is simplified. It is also likely that your credit rating will improve particularly if you include all of your credit card accounts in the consolidation. On top of these advantages, the monthly repayment on the consolidation loan can even be less than the sum of the repayments on the multiple loans.
Why should this be? One factor is that the term of the consolidation loan may be (much) longer than the various terms of the original loans. A second factor is that you may have agreed to allow the consolidation loan to be secured on your property. Lower monthly repayments are usually based on one or both of these factors.
While the interest rate on the proposed consolidation loan may be lower that the rate you are paying on (some of) your accounts at present, the total amount you will have to repay could be considerably increased due to the length of the term of the consolidation loan.
So what can go wrong? If you are struggling to make your repayments at present you need to ensure that you can comfortably make the consolidation loan payments in a sustainable way and for the full projected term of that loan. You need to stop using the credit lines that you have consolidated. For example, you need to cut up all the credit cards you had and stop using any overdraft facilities or other credit facilities which contributed to your financial difficulties in the first place. When you have paid off all your accounts and credit cards with the proceeds of the consolidation loan, you will find that your ‘old’ creditors may want to do further business with you and make all kinds of ‘attractive’ credit offers to you. It is best to resist such offers, if you want to avoid struggling again.
Another disadvantage of taking out a consolidation loan is that you may be persuaded to agree to secure the consolidation loan on your property. If you are unable to keep up the repayments (on the consolidation loan) you may lose your property. While you may achieve a low interest rate by agreeing to secure the loan on your property, the likely long term of the consolidation loan means that you give up some flexibility relating to your mortgage e.g. being mortgage-free when you expected to be or being able to retire early or when you had planned to retire.
So, do think long and hard before you decide on debt consolidation as a solution for your financial difficulties. Consider whether other options may be more appropriate to your circumstances. For example you may already be insolvent. If you are you might consider entering into an Individual Voluntary Arrangement (IVA) or petitioning for your own Bankruptcy (BCY). These are two personal insolvency processes that protect you from your creditors and that have the full weight of the law behind them. Even if you are not insolvent, you might consider entering into a Debt Management Plan (DMP) with your creditors. You can do this yourself by reaching agreement with each of your creditors as to how you will repay your debts to them. This is sometimes called a self administered DMP. Most DMPs however are administered with the assistance of specialist debt management companies with expertise in negotiating with creditors and in setting up DMPs between consumers and their creditors and then administering these plans over a period of years and in some cases over many years. Whatever you ultimately decide to do, do take advice. Do not assume that debt consolidation is the answer to your situation until you have become aware of the other options which may be open to you and have fully considered them.