If you’re in multiple forms of debt, such as credit cards, store cards, and personal loans, you could apply for a debt consolidation loan to pay off debt. It sees you take out a new loan that is (ideally) at a lower rate of interest. Once you receive the lump sum, you use it to pay off your current debts and then you’re only required to meet the repayments on the loan you’ve just taken out. In this article, we look at how debt consolidation loans actually work and how you can apply for one.
Your credit score and debt consolidation loans
It’s important to note that there’s no such thing as a single credit score. Rather, different agencies have different ways of calculating your score. In the UK, there are three credit bureaus – Equifax, Experian, and TransUnion – and they all have different ways of calculating your credit score. That being said, each union will consider your track record of paying back debt, whether you have any missed payments or CCJs, and how much credit you currently have available.
How do lenders arrive at your credit score?
Lenders all have different scales for working out your credit score, as do the bureaus. For instance, Experian give scores between 0 and 999, while Equifax’s score is thought to be out of 700. While a good credit score is helpful, it’s not the be-all-and-end-all when you’re applying for a loan to pay off debt. Some lenders also use Open Banking data, which allows them to consider your current financial circumstances alongside your credit score. But the better your credit score, the less interest you will have to pay on your debt consolidation loan.
How much should you borrow to pay off your loans?
If you think that a debt consolidation loan will help you, the next step is to decide how much to borrow. Your first job is to calculate the value of your outstanding debts, but you will also need to think about things like early payment fees. When you’ve covered all bases, you will arrive at the figure that you need to borrow to clear your current debts.
What about the repayment period?
Next, you need to think about how quickly you want to repay your debt consolidation loan. If you pay it off quickly, your monthly repayments will probably be higher, but you will get out of debt faster. Conversely, if you repay the debt more slowly, you will be subject to lower monthly payments, but it will be more expensive in the long run. Let’s look at a simple example to illustrate this point.
Imagine you have debts totalling £5,000, and you agree on a loan to pay off debt with an interest rate of 10%. If you repay the debt over one year, you will end up paying £5,500 back (£458.33 per month). However, if you extend the repayments over five years, you will end up paying £7,500 (£125 per month). As you can see, the repayments are much lower in the long run, but you would end up paying £2,000 more. In most cases, it’s best to pay off a debt repayment loan as quickly as you can. Helpfully, most lenders allow you to set the terms of your loan, so you can easily calculate favourable repayment terms based on your personal circumstances.
How to apply for a debt consolidation loan
Applying for a loan to pay off debt is straightforward. If you apply for an unsecured personal loan from a third party lender like Koyo Loans, you will be asked what the purpose of the loan is. Debt consolidation is a perfectly legitimate and acceptable reason to borrow money. The good news is that most modern lenders have loan calculators that you can use, which gives you an idea of how much you can borrow, as well as the representative APR rate. You will find that in most cases, a debt consolidation loan is fixed rate, so the interest will be fixed for the entirety of your loan. You can typically pay it back via direct debit, making it relatively straightforward to manage.
So, if you’re looking for a loan to pay off debt, a debt consolidation loan is the best option for you.