Back to Knowledge Hub

What does a debt consolidation loan look like?

Helpful Money Tips

Paying more than one debt at a time can be complicated and stressful. If you are in this situation, it may be a great idea to pack them into one consolidated loan.

What is Debt Consolidation?

A debt consolidation loan is also known as debt refinancing. It is a way of taking out a new loan to pay off all your existing loans. This will help you manage your finances and focus on one repayment only.

How Does Debt Consolidation Work?

Instead of having lots of small separate loans, it’s the process of “consolidating” them (i.e joining them all into one) so you only have to worry about one repayment.

Here is an example to help explain it further. For example, here is a list of debts a person may have.

Credit Card: owing $2000 Store Card: owing $1700 Personal Loan: owing $900 Store Loan: owing $300 So in total, the person above owes $4900. Now let’s look at the current monthly payments they need to make.

Credit Card paying $100 per month (to clear the debt in 2 years) Store Card paying $98 per month Personal Loan paying $95 per month Store Loan paying $47 per month Therefore, each month they need to pay $340 to four, separate lenders. Now let’s consider just one debt consolidation loan for $4900.

One Loan of $4900: The monthly payment would be $240.00 (assuming 16% interest over a term of 2 years) As you can see, this has reduced their total monthly loan payment by $100, which is a significant saving. Plus it makes it easier to manage given there will only be one lender to deal with, as opposed to four.

Is Debt Consolidation a good idea?

Here are the key advantages when you take a debt consolidation:

  • Lower payments A debt consolidation loan will generally reduce the monthly repayment amount compared to what you are currently paying. This is the major benefit of a debt consolidation loan, as it is designed to improve your cash flow.

It would be an unlikely choice to take out a debt consolidation loan if the monthly repayments end up costing you more than what you’re paying now.

However, this would make sense if you can financially afford to do so, and you have a set priority to clear all of your small debts once and for all. For example, if you are planning to buy a house very soon and want to clear all of your small debts before you apply for your mortgage. We discuss this in more detail later.

  • Easier to manage one loan With a debt consolidation loan, you will have one new repayment to focus on, rather than a number of them. This will make it much easier for you to budget, as you won’t have to make separate repayments on different days to different lenders.

Even though you may have direct debits in place, having the money in your account to cover the numerous payments when they are due can be tricky.

Ultimately if one of your direct debits doesn’t go through, you then can be up for late payment fees and possible penalty interest so having just one repayment to come out should make it much easier to manage your finances.

  • Less chance of dishonour fees and impact on your credit report This goes hand in hand with easier to manage. Having several smaller loans that have different repayment due dates, it can mean it’s potentially more likely you can get caught out without enough money to cover the repayments throughout the entire month.

Not only does this mean you could be charged dishonour fees and penalty interest, but it affects your credit rating which will impact how lenders look at you when you apply for another loan in the future.

Does consolidating debt affect credit score?

Debt consolidation does not negatively affect your credit score. When you consolidate your loans, it may have little effect on your credit score at first, but it can help you to improve your credit score as time goes by provided you make on-time payments.

The Bottom Line

Debt consolidation can be a great idea to manage several loans. It can help you in paying your loans a lot quicker and can help reduce the overall cost of interest. If you use it right and pay your repayment on time, debt consolidation can also help to improve your credit score.