Countries such as the US and the UK have scarily high levels of personal debt. In the UK, for example, the average adult has debt of over 4,000 and that’s excluding mortgages. Many of those of us who have some debt are perfectly able to service it but sadly there are many others who are slowly drowning under their mountain of debt repayments. Debt consolidation isn’t a magic pill but can be part of a recovery plan for such individuals.
Typically people, who would benefit from debt consolidation, have a personal loan, credit cards and have run up an overdraft. They are unable to pay off the credit card bills in full each month and are finding it increasingly difficult just to service the interest payments and avoid exceeding their overdraft limit. Rather than continuing to struggle with their repayments, or burying their head in the sand, a sensible approach may be to approach their bank to discuss options.
Debt consolidation, as the name suggests, involves taking all your unsecured debt and rolling it into one personal loan. To take an example, let’s say that you have a personal loan balance of $4,000, credit card debt of $10,000 and an overdraft balance of $1,000. You’ve therefore got total unsecured debt of $15,000. You’re paying 6% on the loan, 10% on the credit card and 15% on the overdraft. It would therefore clearly be in your advantage to switch all of that debt onto the loan, so that you would just be paying the lowest interest rate. Provided that the bank approves you for the loan, you would see your monthly payments immediately drop.
It’s worth reflecting on a couple of the downsides to debt consolidation. Firstly, loans have fixed repayment schedules whereas credit cards and overdrafts don’t, so you lose a little bit of flexibility. Secondly, if you don’t break your credit card habit, then you might just end up with a bigger loan and still accumulating credit card debt.
Another point worth checking is whether the bank is offering you a secured or an unsecured loan? With secured loans, if you don’t keep up repayments, you will forfeit whatever security the loan has been agreed against. A mortgage is the most typical example of a secured loan, with the principle being that you will forfeit your home if you fail to keep up repayments. However most personal loans are unsecured, including (in the UK at any rate) most debt consolidation loans. The downside to unsecured loans is that the rates are normally higher (as the bank’s taking on more risk) so there are pros and cons to both types of loan.
If in doubt as to whether debt consolidation is right for you, then you should speak to a financial adviser who will be able to go through the facts and figures and any other options that may be on the table. Certainly, though, for the borrower who is committed to paying off their debt, and is prepared to be disciplined in their approach to debt repayment, then a consolidated loan can be a very useful option.
Once you’ve decided that you would to consolidate your debt, the next step is to approach a lender. You will be asked to complete a loan application form and a credit score will be done to see whether the bank is prepared to offer you the loan. Typically, you will have a greater chance of success if you are speaking to your existing bank, especially if you have been open with them about your debt position.
Assuming that your application is approved, the bank will then take responsibility for making sure that your existing debts are rolled up into the one loan account. You will have agreed on the duration of the loan (what the bank may refer to as the loan term) and how much you will need to repay per month. You may also be asked whether you want to take out loan cover insurance but you are not obliged to take it.
The loan will then be opened in the same way as any other loan and you should receive official documentation to outline the terms and conditions, etc. Payments will then be scheduled to come out of your account on a monthly basis for the duration of the loan and it may be desirable to arrange for these payments to come out of your bank account just after pay day. Hopefully, by going through this process, you will see an instant reduction in your monthly debt payments and this can give you the financial breathing space to get onto a more even keel.