Debt consolidation entails replacing a number of loans and or credit card debts with a new single loan with one monthly payment instead of several. This payment can often be lower as the repayments are usually spread over a longer period, giving the borrower more chance to manage and pay off their debts. It is especially useful for consolidating credit card debts which usually carry a very high interest rate.

How do I raise a new loan?

There are three ways:

• apply for an unsecured loan, for example from your bank
• remortgage
• take out a secured loan on your property.

Unsecured loans carry less risk of you losing your home if you default in repayment and they usually attract slightly higher interest rates than secured loans.

A remortgage will generally provide the most attractive interest rate but if you are tied into an existing mortgage with an early redemption penalty*, a secured loan could be taken out until the redemption period has expired and then the remortgage option can be pursued.

Of course, if your home is rented then you cannot raise money against it.

Debt consolidation of credit card debts

Credit cards usually carry the highest rate of interest for borrowing money. Paying off card debts by way of one unsecured loan with a lower interest rate will save money and make the debts more manageable. For example, you could have 3 or 4 credit cards with balances totaling £15,000 with an average interest rate of 19% but taking out one new unsecured loan at say 8% will save 11% interest on your credit card debt.

However it is vitally important that you stop using your credit cards to supplement your income and stop amassing credit card debts. To see what you can afford and how much you would save if you consolidated your debts, use our acclaimed budget planning forms here at www.debtwizard.com

The pros and cons of debt consolidation.

Pros

• You have a manageable monthly payment.
• By paying off your existing debts in full you will maintain a good credit rating.

Cons

• Although the monthly payments can often be lower, the total amount repaid may be higher in the long run due to the length of the loan.
• If you are changing the status of your unsecured debts to secured and you default on this secured loan you could lose your home.
• Debt consolidation sometimes only treats the symptoms of debt and does not address the root problem

When not to consolidate your debts

Often people think the only way to get out of debt is to borrow, sometimes borrowing more than the value of their home. This may seem like a good idea at the time but it usually only delays the inevitable and the new remortgage or secured loan then becomes unmanageable.

Make sure you know what equity there is so that if you secure a loan on your property you do not over secure on its value.

Too often families with debt problems take on further debt that they cannot afford. One family, with a home valued at £200,000, a current mortgage £160,000, with equity therefore of £40,000, raised £70,000 to clear their credit card and personal loan debt. Although it may have been be attractive initially to borrow so much because the monthly repayment was lower than that being paid out on the debts, they have over secured the debt on their house to the tune of £30,000.

A better solution would be to establish exactly how much could be afforded to be raised, let's say £30,000 instead of the unrealistic figure of £70,000, which would then be offered to the creditors, in full and final settlement via an Individual Voluntary Arrangement. (IVA)

Every case is different however and what may work for one person may not necessarily be appropriate for another.

Explore all your options first

Before going down the debt consolidation road, explore what other options may be available to you. Identify exactly what it is you wish to achieve and then put together a budget to see if it is affordable. In the above example the debtor is insolvent, he cannot afford to pay back the loan of £70,000 with interest on top of his mortgage and he will fall further into debt and possibly lose the home in a year or two. In the bankruptcy scenario the Official Receiver will take his/her fees and creditors will receive very little return. In this case an Individual Voluntary Arrangement funded by a smaller remortgage would have been the sensible, affordable way forward.

* Redemption Penalty: A financial penalty payable to the lender if the borrower changes lender or repays the amount borrowed before an initially agreed period of time.

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