This is a guest post from Sara Williams who blogs about debt and credit ratings at Debt Camel. She is also an adviser at Citizens Advice.
It sounds such a sensible idea to consolidate your debts – not only will you pay less interest but it will be simpler to only have one payment a month.
It’s not always a good move though – it’s possible to get into much bigger financial problems if you get this wrong. So here are some DOs and DONTs to make sure you get this decision right.
DO shop around
You may have seen a tempting looking offer at the supermarket checkout or been sent it through the post. But do some research and see if there are cheaper loans that you could get. And make sure any loan application is only going to be a “soft check” on your credit record, otherwise a refusal could make your life harder for the next application.
DO close down any credit card and catalogue accounts
Leaving these accounts open is the most common error people make. It’s so common that many debt advisors tell people never to consolidate just because of this risk!
If you leave those credit cards open, with no balance, they are just waiting for you to use them again. In a year or two you can have maxed out cards and the consolidation loan as well. And consolidating again will be much harder as you would need a much better loan.
So avoid this problem by closing down all your accounts apart from one credit card for an emergency. Try to keep the card with the lowest interest rate, if they are much the same, keep the oldest card. Reduce its credit limit if it’s large – £2,000 should be more than enough. Then the best thing for your credit rating is to use the card every month for something small such as one supermarket shop and repay the card in full automatically each month. It is not better for your credit rating to leave a balance on the card.
DON’T borrow more than you need
Some lenders offer lower rates for larger loans. Don’t get tempted by this! It may sound good but it’s more debt and will be more interest overall.
If you borrow more now because it looks cheap, and use the extra for a holiday, you are still going to be paying for that holiday for the next few years. And having the large consolidation loan may make it harder to get other credit in future, so you may not get cheap car finance or a mortgage because of the large consolidation loan.
This also applies if you have a large loan that is ending soon. The next few months will be hard until the loan goes, but then it will all be over and you will be able to pay off your credit card debt much faster. By consolidating this debt you are repaying it – with interest – over a longer period.
DON’T consolidate cheap debt
The idea of just one payment a month can sound so attractive. But it’s a mistake to consolidate debt which isn’t expensive, because you will be paying for it over a longer period. If you have a loan you are paying 7% on at the moment and it has 7 months to run, you won’t be saving money by consolidating it with a 4 years loan at 4% – you will be paying more interest over a longer period.
DON’T get a secured loan
If you get into financial problems because of your job or health, there are debt options to help you manage unsecured debt. There are no options if you have got a secured loan.
You have turned expensive debt into dangerous debt. And many secured loans are variable rate – so if interest rates go up in the next couple of years this loan could get more expensive too.
Having a secured loan will make it harder to get a re-mortgage at a good rate too as you have less equity So you could end up paying more for your mortgage than you are saving through the consolidation loan.
STOP if you have a bad credit record
If you have a poor credit score, then you won’t get a consolidation loan at a good rate. Logbook loans, guarantor loans, poor credit lenders may be charging 50% or even more…
This may still look cheaper than your expensive credit card and payday loans. And the loan repayment may sound affordable for next month – but will it be for years? What if you get unexpected expenses? It’s better to look at your debt options first before you load up with these expensive debts.