How to use a personal loan for debt consolidation
If you have a handful of outstanding debts, it may be cheaper and more manageable to consolidate them into one personal loan.
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While many borrowers use personal loans to raise money for big expenses like weddings or home renovations, they can also be used to consolidate outstanding debts – for example, credit cards, department store cards, overdrafts or other loans.
To do this you simply use the money raised by the personal loan to ‘pay off’ your debts. You are essentially transferring all the outstanding amounts into one loan so you’re left with just one repayment to deal with every month.
The benefits of debt consolidation
If you manage to get a lower rate of interest on your new loan, you may be able to reduce your borrowing costs and lower your monthly repayments.
Furthermore, making regular monthly repayments (rather than ad hoc or minimum payments) will stop interest charges from spiralling and prevent your debt pile from getting bigger.
Many borrowers also appreciate having all their debt in one place and only owing money to one company. They will also have a clear date when they know they will be debt-free.
» MORE: Calculate loan costs
How to get a personal loan for debt consolidation
Try to find the lowest rate you can to keep the cost of borrowing to a minimum.
Be aware that loans are promoted with a ‘representative APR’ (annual percentage rate) and this interest rate only has to be offered to 51% of applicants. The lender will only tell you the rate it will offer you once it has checked your credit record to find out whether you are a reliable borrower.
Before you apply, it’s worth taking advantage of a free eligibility checker. This will give you an idea of which lenders are likely to approve your application without running a full credit check on you, which could potentially damage your credit score. It may also tell you what interest rate you’ll get if your loan is approved.
When you apply, the lender will need to get some basic information about you and your finances and run a full credit check to ascertain when you are a reliable borrower.
It will then confirm whether it will offer you the loan. Your money should usually be paid into your account within a matter of days.
Although many lenders allow borrowers to use personal loans for debt consolidation some do not permit it, so make sure you check this first.
Personal loans vs debt consolidation loans
You can often use a regular personal loan to consolidate your debts. However, when you research debt consolidation you will invariably come across specific debt consolidation loans too.
This can confuse matters somewhat. The reality is that an unsecured debt consolidation loan is simply an unsecured loan (or personal loan) that is targeted towards borrowers who want to consolidate debt.
The key when shopping around is simply to focus on getting the best interest rate you can.
With personal loans, the best deals will be reserved for the people with the highest credit scores.
Just because you have debts to consolidate it doesn’t necessarily mean you are not a reliable borrower and many people will be able to get personal loans at competitive rates for this purpose.
If you have a poor credit history and have debts to consolidate, you may find it harder to get a standard personal or unsecured loan.
In these cases you may need to use a specific debt consolidation loan from a lender that is more open-minded to borrowers with lower credit scores. However, interest rates may be higher than standard personal loans.
If this route fails, but you own your own home, you may be able to get a secured debt consolidation loan.
Will a debt consolidation loan harm my credit score?
By making regular and timely repayments, any loan should provide an opportunity to improve your credit score over the long term. However, if you miss or are late with payments, it will have a negative impact on your credit record.
It is also worth noting that applying for a loan and then closing a handful of loan accounts, such as credit cards, could potentially lower your credit score in the short term.
Can I use credit cards after I have consolidated my debts?
If you have consolidated credit card debts but still have those accounts open, there is nothing to stop you from using them. If you closed accounts, you would need to apply for a new credit card, and the deal you get depends on how good your credit record looks at the time.
However, if you have reached a point where you have felt the need to consolidate your debts, it makes sense to think very carefully about whether you can manage to repay new credit card debt on top of your consolidation loan.
If you feel that you need help with your debts it is worth contacting a debt advice charity.
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Rachel Lacey is freelance journalist with 20 years experience. She specialises in personal finance and retirement planning and is passionate about simplifying money matters for all. Read more