Debt consolidation involves taking out one large debt to pay out several old smaller debts, which would then be closed. An unsecured personal loan is what most people associate with debt consolidation. This is ideal where you have several short-term, high-interest debts (e.g. credit card debts, payday loans and overdue bills). The main benefits are a lower interest rate, and the convenience of one payment. Credit cards have very high interest rates, meaning that you could end up paying double or even triple the original sum. Unsecured debt consolidation loans typically have lower interest, with a set time frame.
Example: Helen has three separate credit card debts totalling $9,000.00. Each card carries a different interest rate, and each payment is due at a different time. This makes it very difficult for her to keep track of her finances and ensure that repayments are paid on time. She is charged an average interest rate of 19% per year, and has already paid more than the value of the original debt. Deciding that enough is enough, Helen applies for a debt consolidation loan. She uses the money from the loan to pay off her credit debt. Helen now has a loan for $9,000.00 over 7 years, with an interest rate of 15.45% per year. Her monthly repayment has only gone down $4.00, but at least she will be debt free in 7 years.
|Credit Card 1||$3,000.00||$60.00||19.00%|
|Credit Card 2||$2,000.00||$40.00||17.00%|
|Credit Card 3||$4,000.00||$80.00||21.00%|
|Debt Consolidation Loan||$9,000.00||$175.95||15.45%|
Discussion: The above example is good outline of the benefits and disadvantages of debt consolidation. She only has one repayment to make and will be debt free in a definite time period (7 years). Her repayments have not decreased by much ($4.00/month); not quite the huge reduction that most people expect. The 7 years it will take her to repay the debt is longer than generally expected. Debt consolidation loans may also carry various fees and charges.
Debt consolidation is one option in a range of debt solutions. For information on the range of options available, take a look at our Debt Solutions page. You must determine whether the information is appropriate in terms of your particular circumstances.
NB: Beyond Debt is not a lender. We do not provide debt consolidation loans. We can assess the suitability of several debt solutions for those experiencing difficulty with their debts.