The road to debt freedom could start with debt consolidation loans
Borrower guides

Quick guide to debt consolidation loans

Having launched our platform more than two years ago, we’ve observed some interesting trends among our customers. One of the more intriguing shifts we’ve noted among our borrowers has been an increase in the percentage of those opting to use a Lending Works loan to consolidate their debt. In fact, more than 30% of the loans we now approve are for debt consolidation purposes.

Debt consolidation loans are something we often champion, as it is indicative of consumers taking charge of their finances, and making sensible decisions in order to accelerate their quest to become debt free. So what exactly does it all entail? And when is it an appropriate action to take?

Understanding debt consolidation loans

The idea behind consolidating debt is very simple. Rather than juggling a variety of obligations such as credit cards, overdrafts and other high-interest debts, it makes practical sense to gazump the whole lot with a solitary, low-cost loan to pay them all off.

On one hand, you’re saving yourself an enormous amount of hassle in terms of convenience, given that you’ll no longer be worrying about multiple debts, with differing APRs, monthly repayment dates and repayment amounts. But more importantly, by leaving yourself with a single loan with an APR lower than the collective of your previous debt(s), you’re potentially saving a fortune in interest, and therefore reducing your overall liabilities.

Debt consolidation and credit cards

The most common type of debt our customers look to consolidate is that of their credit card; which is why these type of loans are sometimes referred to as ‘credit card refinancing loans’. And it makes sense, especially when you consider that the Representative APR on credit card purchases in the UK (as stated in the UK Cards Association September 2015 Report) is 17.9%. At Lending Works the representative APR on a £5,000 loan over three years is currently just 6.4%.

What’s more, one of the big killers for those with large credit card balances is making only the minimum repayment amount each month. Credit card providers often encourage this, with short-term 0% APR offers and/or setting very small repayment minimums. It can thus deflect a borrower’s focus away from paying off the capital balance as quickly as possible in favour of spending their money on other things.

This, in turn, leaves them stuck in this cycle of debt for longer, paying more and more in interest, and ultimately filling the pockets of credit card companies while leaving a big hole in their own. A personal loan provider, on the other hand, would generally offer a robust monthly amount devoid of such temptations, ensuring that you pay off your debt quicker and save a lot more in interest in the long run as a result.

Are there any risks with debt consolidation?

If, after consolidating your debt, you are left paying less in overall fees and interest, then, on the face of it, there should be no risks or drawbacks to your decision. However, there are certainly some questions you should ask of yourself - or any lenders you may be considering - before deciding if debt consolidation loans are for you:

  • Is this just a short-term fix? Have minimum repayments been all you could afford, or will you be able to meet the repayments of the new debt consolidation loan?
  • If the repayment amounts on the new loan are lower, is this because you’re putting yourself in debt for longer than with your previously existing debt(s)? If so, will you be paying more interest over time as a result?
  • What fees and charges are involved with your new loan? Will you be penalised for late payments, or early settlements?
  • Is your credit score optimised? This is the main determinant of what your APR will be for a debt consolidation loan, so it may be worth taking some steps to improve your credit rating before applying for it

Applying for your loan

If, having factored in the above, you decide consolidation is the way to go, then good on you for taking proactive steps to save yourself money! The good news is that applying for this type of loan is usually very straightforward. At Lending Works, for example, it is as simple as getting an online personalised loan quote, taking two minutes to complete the application, and then waiting one working day for a decision. It is also advisable to read the fine print and ask all the questions that need to be asked in order to ensure that you have a loan that you fully understand, and with a repayment structure you are comfortable with.

And, most importantly, keep up the positive momentum. After all, you’ve just made a responsible decision to reduce your overall debt. With an ostensibly ‘clean slate’, it may be tempting to now up your spending. Make sure you avoid these kinds of temptations though, and rather prioritise your remaining debt. This is the ticket you’ve given yourself to a debt-free life. Be sure to stay the course!

Main image "Credit Card Debt" by Got Credit. Image subject to copyright. A link to the image and appropriate licence can be found here. You must not use or reproduce this image other than in accordance with the licence.

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Michael Todt

Mike joined Lending Works in early 2015 with a background in marketing and journalism. Having long held a passion for economics, he is now the chief contributor to the Lending Works blog, and regularly writes about all things peer-to-peer lending, fintech and personal finance.