Debt consolidation is one of the hottest financial trends among borrowers accustomed to juggling numerous personal loans and credit card accounts. Laura Pomfret, a financial coach, reminds people that you have to consider more than the loan’s monthly payment. She points out the importance of factoring in the overall cost before any purchase or investment. This guide breaks down the challenges of debt consolidation and points out the advantages it can have. It looks at the key issues surrounding individual debt in the UK.
Debt consolidation involves taking out a new loan to pay off existing debts, thereby leaving borrowers with a single fixed monthly payment to one lender. This strategy can streamline repayment and in some instances lower the total interest amount paid on loans. Yet, it is so important that people are truly aware of what such a move would mean.
Pomfret points to a technical and potentially very expensive problem. On average, borrowers managing multiple loans—the most common scenario by far—spend over three and a half years repaying their loans. Shockingly enough, four out of five people don’t even think to take advantage of debt consolidation. This lack of awareness can result in extended fiscal misery.
Personal borrowing has evolved enormously as well. Short-term high-cost credit remains pervasive, despite the retreat of many payday loan brands. Payday loans used to be an immensely profitable sector in the UK, hitting their zenith in the early 2010s. Yet their ascent changed the game forever on Wall Street. In the UK, companies like Wonga were known for providing predatory rates, with average APRs being over 4,000%. For example, a £100 loan can leave borrowers with repayment costs of many hundreds of pounds if they repay them in only a few weeks.
Pomfret recommends considering safer options before turning to debt consolidation. These could be credit-union loans or local welfare systems that provide better conditions. Having conversations with bodies like StepChange or Citizens Advice can help you to identify the best guidance on establishing good repayment plans.
To better understand how debt consolidation works, let’s consider the following example. Take as an example someone who has £3,000 owed on a credit card, £1,500 on a store card and £1,000 on an overdraft. Ultimately, this borrower is stuck with an inescapable burden of £5,500 of debt. A consolidation loan that lowers their monthly payment from £200 to £120 may sound enticing. If you stretch that loan out over five or six years instead of three, you would pay thousands more in total. This is a repayment amount that can easily overshadow the original liabilities.
For example, if you took a £5,500 consolidation loan over five years at an APR of 11.9%, you’d pay roughly £122 a month. Under this plan, you can pay off your debt in full by the end of the repayment period. The combined interest on this consolidation loan comes to more than £1,800. This contribution is substantially less than their individual payments would be if they maintained their individual obligations.
Still, it remains imperative for borrowers to thoroughly assess their own financial circumstances. If someone is having a hard time making current payments, debt consolidation will not solve their financial problems. In these cases, increasing repayment times only increases their burden. It doesn’t do anything to address the underlying causes of their student loan debt.
Honest advice like Pomfret’s should be a clear warning sign for anybody thinking about debt consolidation. They need to do better than just comparing expected monthly payments, but help to compare the overall costs from different loan options. By taking these actions, they can ensure the decisions they make are good for their bottom line in the long run.
