Debt Consolidation Loans and Mortgages

If you’re struggling financially, you may be tempted by debt consolidation loans and mortgages as ways to simplify your situation. But before you take out more credit, it’s important to consider whether it’s the best way to solve your problems.

If you’re being chased by creditors, then you can ask them for time to put a solution in place using our DebtBuffer letter templates. These make it easier to explain that you’re currently arranging a debt repayment plan. Or, if you feel you fit the criteria,ask them to class you as a vulnerable person, which means you should receive more care and consideration in how they communicate with you.

What is a debt consolidation loan?

The idea of a debt consolidation loan is simple. If you’re struggling to manage multiple debts and repayments, then it can be easier to merge them all into one loan. That way, you only have one debt, and the repayments may be lower.

You borrow just enough to cover your existing debts, and it can be a lot easier to keep track of one payment when it comes to managing your budget and cashflow. Whether you save on the repayments will depend whether or not you can find a lower interest rate than you’re currently paying.

There are two types of debt consolidation loan;

• Secured: Any money you borrow is secured against an asset, usually your home. Which means you could potentially lose your property if you miss repayments.
• Unsecured: Your loan is not secured against any assets. There’s a maximum limit of £25,000 for unsecured debt consolidation loans

It’s important to get free and independent debt advice before taking out a debt consolidation loan, particularly if it’s likely to be secured against your home.

And remember that other options do exist to deal with your debts in one monthly repayment, such as Debt Management Plans (DMPs) and Individual Voluntary Arrangements (IVAs), although each option has positives and negatives. So, you need to look at all the options, and get advice on each, before making a decision.

It may be possible to also use a personal loan to consolidate debts, or transfer smaller credit card debts to a 0% balance transfer alternative.

If you’re struggling with problem debts, and missing payments or receiving defaults, then you need to give yourself time to find the right debt solution. You can do this with the DebtBuffer letter templates to request time from creditors to put your plan into action, or if you feel you meet the criteria, to be classed as a vulnerable person, which entitles you to more consideration and care.

Are debt consolidation loans a good idea?

Any debt solution is only a good idea if it fits your current circumstances and future plans. A debt consolidation loan can be a worth considering if you can reduce your debts and manage your finances more effectively. But it might not be the best option, for reasons we’ll cover in detail below.

Signs that you could benefit include;

• If you have savings which won’t be wiped out by loan fees and charges.
• You can afford to keep up the payments until the loan is repaid.
• The interest and total amount payable are less than on your existing debts.
• The loan itself won’t impact your credit score, beyond a credit check for your application.
• Defaults and debt management solutions can impact on your ability to work in certain careers.
• It’s used as an opportunity to cut your spending and sort your finances.

With any problem debts, you will always get better options if you act sooner, rather than later. Not only will you be able to access better debt consolidation loans, but other options including 0% balance credit card transfers are available if you have a good credit rating.

If you miss payments or start to receive default notices, then the better deals will start to disappear. And this will make a debt consolidation loan a less viable option.

What are the negatives of debt consolidation loans?

The main downside of a debt consolidation loan is that you’ll be repaying the full amount owed, including interest. Other debt solutions can encourage creditors to freeze interest and charges (such as a DMP), or will write off a percentage of the money you owe (IVAs, or Bankruptcy, as examples).

You’ll only end up with smaller repayments if you are able to secure a lower interest rate. And even then, you might end up paying more in total over a longer period of time.

The negatives of debt consolidation to consider include:

• If it will be difficult for you to afford the new repayments
• You aren’t able to include all of your debts in the loan
• You end up paying more either due to higher interest or a longer agreement
• If you still end up accruing more debts, and can’t sort out a workable budget even after taking out a loan
• A secured debt consolidation loan against your home means missing repayments puts your property at risk
• If you take a debt consolidation mortgage and the value of your property falls you may find yourself in higher levels of negative equity, should you need to sell the property before the debt is paid off.
• You need to check for any fees on paying off existing loans early, or for your new debt consolidation loan.
• Other debt solutions can end contact from creditors, and prioritise mortgage payments or secured loans to reduce the risk of repossessions.

You need to be honest about your situation, and your ability to manage your finances. If you’re normally capable of managing your budget and debts have just crept up for temporary reasons, then a debt consolidation loan could make a lot of sense.

But if you’ve been struggling with problem debts for some time because you just can’t afford them, then it’s not going to be the best option. And you will need to be able to organise your budget, and be able to compare different financial products. So, there’s no shame in admitting that this might not be your strongest skill, and getting help from a specialist debt charity or organisation.

Do debt consolidation loans hurt your credit score?

A debt consolidation loan has no negative impact on your credit score. The only drop you are likely on your credit report will be for the hard credit check which will happen when you apply for the loan.

Hard credit searches have a minimal effect on your credit score for a short period of time. But they will usually stay on your credit report for 12 months. The biggest risk is if you apply for lots of different credit, and multiple checks can affect your credit score for 6 months or more.

Obviously if you take out a debt consolidation loan and miss payments, or default, then this will impact your credit score and remain on your file for 6 years. This removes one of the main advantages of consolidating your debts, so it’s important to ensure any loan repayments are affordable.

How long does a debt consolidation loan stay on your credit report?

The three main credit reference agencies in the UK will update your report on a monthly basis. When you apply for any credit or loans, including for debt consolidation, if it requires a hard credit check, this will typically stay on your report for 12 months.

While a loan or other credit account is open, up to the last six years of repayment history can be reported. When it’s closed this will be dated from the closure date. And under normal circumstances, any loans will be removed from your credit report six years after closure.

This isn’t actually a bad thing, as long as you’re making payments. Using a debt consolidation loan and meeting your repayment commitments will improve things, particularly as you start to lower how much of your available credit is being utilised. Not only are you making regular payments, but it also means you will be utilising less of any previous credit accounts.

So, you shouldn’t worry about how long a debt consolidation loan will show on your credit history, particularly if it saves you from problems which will have a big negative impact.

Can you get a debt consolidation loan with bad credit? What’s the minimum score needed?

No lender will set a minimum credit score for a debt consolidation loan. Mainly because the decision to lend any money to you will be based on the detailed history in your full credit report, rather than just credit scores.

Even with a bad credit rating, it can still be possible to get a debt consolidation loan. But you will find less options available to you. And the debt consolidation loans that you can get will have much higher interest rates, and typically need to be secured or guaranteed by a third party.

And if you’ve already got a poor credit history, that removes one of the big advantages of opting for a debt consolidation loan in the first place. And means the negative impact of choosing an option such as an IVA or Bankruptcy, which can allow you to write off some or all of your debts, probably can’t do much more harm to your credit rating. But they are likely to mean you can clear your financial problems and start rebuilding your score more quickly.

Can you pay off a debt consolidation loan early?

If you come into more money, you may want to pay off your debt consolidation loan early, or make a partial overpayment to reduce the amount more quickly.

Whether it’s possible to settle part or all of your loan early will depend on the agreement you signed with the lender. This will have a section detailing early repayment conditions, plus any applicable fees and charges that may apply.

If you want to pay off your debt consolidation loan early, or make a partial overpayment, then you need to speak to your lender. For overpayments, a 28-day notice period applies, and you’ll be charged interest on the full amount for that time. And to pay off your loan in full, you’ll need to ask for an ‘early settlement amount’ which tells you what you might need to pay, and gives you 28 days to consider it.

You may decide it’s worth paying more to finish the loan early, particularly if you might struggle with repayments in the future (for example if you’ve received redundancy money).

And don’t forget to check regularly whether you can save money by switching your loan by paying it off with a new one. As your credit score improves over time by making regular payments and reducing your debts, better offers will become available to you.

Do banks offer debt consolidation loans?

Most high street banks and financial providers such as major supermarkets will offer debt consolidation loans. And typically, you won’t need to have an existing account with them to be able to apply.

When you’re comparing the various providers of debt consolidation loans, make sure you understand when a hard credit search will be carried out, to avoid unnecessary checks harming your rating. And take time to check details such as whether overpayments or full settlements can be made without any charges or penalties.

It’s also important to remember that the representative Annual Percentage Rate (APR) advertising in big letters might be low (e.g 3.9%), but the actual maximum that might be applied could be much higher (e.g. 29.9%) depending on your credit history. You need to compare the actual rates that you’ll get, not the deals being advertised to everyone.

For example, borrowing £10,000 over 5 years at 3.9% APR would cost you a total of £11,004.48, with monthly repayments of £183.41.

Whereas £10,000 for 5 years at 20.9% APR would cost you a total of £15,607, with monthly repayments of £260.12.

Government approved debt consolidation loans

There are no Government approved debt consolidation loans. Unfortunately, some companies have used terms like this to suggest they are officially endorsed. The Financial Conduct Authority has taken action against some companies to stop them advertising in this way.

You may also find some companies use phrases like these on their website, but the details will refer to formal debt solutions such as IVAs and Debt Relief Orders. This is so they’ll appear if someone searches for ‘Government debt consolidation loans’ in Google or other search engines, but they can try to claim they’re not misleading anyone, because the details are about legitimate formal debt solutions introduced by the UK and Scottish Governments.

Debt management can refer to formal plans introduced by the Government to help you manage problem debts, and can be voluntary agreements, such as a Debt Management Plan, or legal procedures including IVAs, bankruptcy or Debt Relief Orders.

Debt consolidation refers to loans which have nothing to do with the UK Government, and are legally equivalent to any other type of loan agreement.

What is a debt consolidation mortgage?

As with a loan, a debt consolidation mortgage allows you to pay off your debts. But you’ll either be remortgaging or switching to a new provider, as you will be borrowing against the existing value of your home. If your mortgage is already around or above 80% of the total value of your property, it will be difficult or expensive to borrow more money against it. And obviously if you’re a first time buyer, then you won’t have any equity to play with yet.

The maximum you can borrow against a property if called the Loan to Value (LTV). Currently the most you can borrow would be 90%, including your existing mortgage. That’s before the lender has looked at affordability and your current credit history.

So, a debt consolidation mortgage will rely on the value of your house, the equity and repayments so far, and your credit history. As with loans and other debt payment options, you’ll get more benefit if you act as soon as your debts start to become an issue.

What are the benefits of a debt consolidation mortgage?

This will depend on both your personal circumstances, and the mortgage rates at the time you’re considering remortgaging for debt consolidation.

As the typical length of a mortgage is much longer than for a loan, it means you have a lot longer to make the repayments. Which means the amounts will be lower on a monthly basis. Our example for a £10,000 debt consolidation loan would mean paying £183.41 per month for five years at 3.9% APR. The same amount within a 20-year mortgage, on the same interest rate, would be £60 per month. But you would pay roughly £3,000 more in total.

If mortgage rates are low, or your existing debts have a high interest rate (e.g. credit card balances, or personal loans), then you may be able to pay a much lower rate by remortgaging or switching to a new mortgage from a different provider.

The other benefit will be if you’re able to organise your budget and finances, avoiding any further problem debts or borrowing. As with debt consolidation loans, the success of choosing to remortgage will depend largely on whether your current issues are an isolated difficulty, or whether you regularly struggle and might end up building up more debts in the future.

Do debt consolidation mortgages have downsides?

We’ve mentioned that a debt consolidation mortgage will mean that you pay more over a longer period. But if you’re looking to reduce your monthly payments immediately, paying an extra few thousand over the next two decades might not be much of a concern.

But it’s also important to remember that a mortgage is a secured loan against your home, whereas your existing debts may be unsecured. This will change the action creditors can take against you, including putting your home at risk if you can’t manage your repayments.

Debt solutions including DMPs and IVAs should always ensure priority debts such as a mortgage, are budgeted for and paid first in your repayment plans.

Remortgaging also means paying a range of costs and fees, which include the early repayment of your existing mortgage, and organising the new one. So, you need to factor these into calculations for any savings.

You might benefit if mortgage interest rates are currently low. But given the long- term nature of mortgages, they are likely to change a lot before the debt is paid. Fixed rate options offer more security, but tend to only last between two and give years, and will come with a higher initial interest rate than a variable mortgage.

It’s important to remember that if circumstances change and property values fall, you may find yourself in negative equity if you need to sell. This means you haven’t paid enough of your mortgage to pay off everything with the proceeds of the sale. And that you’ll still owe your bank or mortgage lender even after the property is sold, complicating your finances whether you are buying or renting a new home.

Shared ownership mortgage debt consolidation

Shared ownership is a mix between buying and renting which is typically aimed at first-time buyers. You buy part of a property to live in, and rent the rest, potentially increasing your share over time in a process called staircasing.

You can potentially remortgage for debt consolidation on a shared ownership property. But many mortgage providers specifically prohibit remortgaging for debt consolidation. And when there are a lot less lenders to choose from, it will be particularly difficult to get a good deal if you have problem debts and a poor credit history.

Should you consider debt consolidation loans and mortgages?

If you’re starting to struggle with debt repayments, it’s important to consider all of the options available. The right solution will depend on your individual circumstances, and that’s particularly true in the case of debt consolidation loans and mortgages.

Replacing multiple debts with one line of credit can make sense if you’re at the earliest stages of debt problems. If you’re able to make sound financial decisions, or get access to specialist financial advice and can locate a debt consolidation deal which replaces high interest debts with a lower rate of repayment, then it can be a beneficial option. Particularly if you still have some savings which won’t be wiped out by loan fees and charges.

You’ll need to show self control to ensure you don’t take out further credit. And it’s worth having a plan in place should your circumstances suddenly change as it may mean you need to switch to an alternative debt solution.

The best potential situation will be if you already have significant equity in your home and property prices are likely to rise. In this case, your debts could be covered by the appreciation of your house or flat, as long as the market moves in your favour.

Debt consolidation makes less sense as your financial problems progress. If you’re struggling to meet repayment amounts and your credit score is already being impacted by missed payments and defaults, good loan and mortgage offers will be harder to find.

If you currently owe unsecured debts such as credit cards, swapping this to a loan or mortgage secured against your home or other assets increases the potential risk if something does go wrong and you’re unable to stick to the repayments for your consolidation loan or mortgage.

So, if you’re considering debt consolidation loans or mortgages, it’s important to be honest with yourself about your financial situation, seek expert and impartial financial advice, and consider what other factors may impact your future. If you are in the early stages of debt problems and the situation is right, you can avoid the burden of more formal solutions which will have a greater impact on your lifestyle and credit history.