What is a debt consolidation loan?
A debt consolidation loan is essentially a personal loan that can help you organise a cluster of debts into a single loan. So, for instance, if you’re juggling multiple debts on your finances, a debt consolidation loan facilitates the process by combining all your ongoing debts into a single loan, which is more convenient to pay off.
You can normally borrow anywhere from £1,000 to £35,000 with a debt consolidation loan over 3-7 years with LoanTube. The idea is to borrow a sufficient amount to cover the debts you wish to consolidate and get a loan term with affordable monthly instalments.
How exactly do debt consolidation loans work?
The goal of debt consolidation is to combine multiple debts into a single loan. In assessing your debt consolidation loan application, lenders look at several factors, such as your credit score, income, and employment.
Your credit score helps the lender determine your ability to repay credit and the risk proposition of lending you money. Thus, the higher your credit score, the lower the interest charged on your loan. The lender will directly deposit the funds into your bank account when you qualify for a debt consolidation loan.
You can use the funds to settle all your outstanding debts following the transfer.
Use the debt consolidation lump sum to pay off your existing debt. You will have only one loan to repay, making repayments more convenient and manageable.
What is a debt management plan?
Debt Management or Settlement is the process of getting a part of your debt waived off, or paying a lower interest on your debt, by hiring a third-party firm to negotiate a settlement with your creditors on your behalf. So, instead of paying what you owe to your creditors, you pay the settlement firm for their ‘service’ of negotiating a settlement.
Debt management plans may seem like the most favourable way of getting out of debt. However, all the repayments you miss until a settlement is negotiated are categorised as defaults or skipped payments. So, a series of missed payments can cause your credit score to drop drastically, which severely impacts your creditworthiness. Debt management can gravely hamper your chances of securing credit for your future goals and financial milestones.
Debt Consolidation vs Debt Management?
Some of the major differences between Debt Consolidation vs Debt Management are:
|Debt Consolidation Loans||Debt Management/Settlement Plan|
|Basics||Consolidate your debts with unsecured personal loans.||Debt Settlement or Management involves hiring a third-party firm to ‘negotiate’ a settlement with your creditors.|
|How does it work?||You borrow a debt consolidation loan to pay off a combined balance on all your ongoing debts. Once you pay off this balance, you’ll have only one debt consolidation loan.||In debt settlement, you usually reach out to a debt management firm that negotiates a settlement with all your debtors on your behalf. So, you will spend the debt settlement firm you hire rather than paying your creditors.|
|Debt range (on average)||Up to £25,000||Usually between £10,000 and £100,000.|
|Interest charges||With a stellar credit history, you may get a low-interest debt consolidation loan. If your credit score is high, the interest rate on your loan will be lower. So, you may not qualify for competitive interest rates with a low credit score.||Debt settlement entails a settlement negotiation, so the average interest negotiated with each creditor is roughly between 10-20%|
|Repayment cycle||Repayment through affordable monthly instalments. The shorter the repayment period, the lower interest you will accrue.||You repay the debt settlement firm a fee for their service. Repayment depends on how much debt remains after the negotiation.|
|What to consider?||While a long-term loan could considerably reduce your financial burden each month, you will accrue a greater interest in the long run. So, weigh the pros and cons accordingly.||An ideal way out of debt is debt settlement. Still, it would be best if you remembered firms encourage you to miss repayments until your debt gets settled with all creditors. These missed payments can drastically lower your credit score, affecting your chances of securing any credit shortly. Thus, it may not be a healthy way to cope with your debt.|
When is it a good idea to consider debt consolidation?
Debt consolidation loans can be a wise choice to settle your outstanding debts in the following circumstances:
- When it simplifies your finances: It is good to consolidate debt if you want a clearer picture of your finances. This way, you can track how much interest you’re paying and what you’re spending.
- It can be challenging to juggle multiple debts at once, making budgeting easier. Furthermore, juggling numerous obligations can make budgeting tricky, and you can alleviate this difficulty by consolidating your debts.
- When you get potentially lower interest rates: Consolidating your debt could reduce your interest costs.
When to consider a debt management plan?
A Debt Management program may be appropriate if:
- You owe an unsecured debt (from credit cards or overdrafts) which amounts to 15-39% of your annual earnings.
- You earn a regular income and anticipate that you will settle your dues within 3-5 years on lower interest.
- You are determined to curb your spending and do not plan on taking new credit lines while enrolled in the plan.
- You can cope with monthly repayments on your priority debts (such as mortgage and rent) and your living costs. Still, you can’t manage the repayments on your credit cards and loans.
- You would like someone else to handle negotiations with your creditors.
- You will budget better if you make a set payment each month.
Is debt consolidation better than a Debt Management Plan?
A debt settlement or management plan is often compared to taking out a loan to consolidate debts, but that is untrue. In debt settlement, a third-party firm negotiates a settlement between you and your creditors, which means that you pay the debt management firm to negotiate between you and your creditors.
Even though debt settlement can feel like you’re getting free of your debt, it’s crucial to understand that this can adversely affect your credit score and report. Late or missed payments will still appear on your credit report. Also, even if you settled your debt, your credit report will indicate that you didn’t pay all of the companies in full. You will most likely see a drop in your credit score; as a result, making it harder to get credit shortly.
- Organise your debt: Managing your payments with different due dates is stressful, but taking control of your situation with a debt consolidation loan gives you some peace of mind.
- Reduce interest rates: You can reduce your interest payments by repaying a high-interest debt with a lower-interest loan.
- Improve your credit score by lowering your credit utilisation ratio: The amount of debt you carry compared to your credit limit can affect your credit score. Consolidating multiple debts can improve your credit score faster because you’re using less of the total credit available to you. Lower credit utilisation can boost your credit score.
- You will need to maintain a low credit utilisation ratio: It may be tempting to start making new charges on your credit cards once you have cleared the decks to a zero balance, increasing your overall debt. These new debts can impede your efforts to jump back to healthy financial habits.
- You may not get a lower interest rate: While debt consolidation loans are an excellent way to cope with high-interest debt, opting for a loan with a higher APR can increase your overall balance towards the loan.
- Financial advisor’s fee may add to your expenses: If you decide to consolidate your debts, you may need to work with a debt counselling agency to lay out a plan for paying off your debts. These agencies charge a monthly fee for their services. As a result, you may get a better financial standing but have to spend more money.
Since you miss a series of repayments before reaching a settlement, debt management plans can leave a negative imprint on your credit report. Here’s what to consider before opting for one:
- Settlement negotiation can help you reduce your interest rate or overall repayment amount.
- Sometimes, it can expedite your debt payoff, making the settlement faster than it would have been otherwise.
- Debt settlement takes into account a variety of debts.
- You can use it mainly to pay off credit card debt; you cannot use it for student loans, medical debt, or tax obligations.
- You generally can’t use credit cards or get new lines of credit while on the plan, and it often takes three to five years.
- If you miss payments, you may lose your interest rate reductions.
People with multiple debts may assume that closing old credit accounts could help increase their credit score. Contrary to popular belief, that isn’t the case. You lower your credit limit when you close a credit account, even if it’s been paid off.
The credit utilisation ratio represents your credit usage to the amount of credit available (your credit limit). You should aim for a credit utilisation ratio of 30%, which means you shouldn’t be using more than 30% of your credit limit. Closed credit accounts result in decreased credit limits, thus increasing this ratio and hence lowering your credit score.
Any credit, including debt consolidation loans, leaves a footprint on your credit report. – How responsibly you use your loan determines whether your footprint is positive or negative. With the help of the debt consolidation loan, you can simplify repayments, reduce your interest payments, and improve your credit score over time.
Following your repayment schedule is crucial to making your debt consolidation loan work. So, make sure that you pay off the loan on time. Also, closing your old account can lower your credit score.
Paying off your debt is good practice, but closing paid-off accounts can lower your credit limit, which will increase your credit utilisation ratio. You can significantly reduce your credit score if you have a high credit utilisation ratio.
A hard credit inquiry can also lower your credit score when you first apply for a debt consolidation loan. However, with a series of sincere repayments, its consequences may be insignificant and lessen over time.
You can borrow up to £35,000 over 3-7 years with LoanTube.