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Is a debt consolidation loan right for you?

Posted on 04 May 2016 by Chris Torney

One of the most popular reasons to take out is a loan is to reduce the amount of interest you’re paying on existing borrowing. By consolidating your debts, it could be possible to cut your monthly outgoings considerably.

But how do you work out whether this course of action is right for you?

Step 1: Analyse your existing debts

Working out the rates of interest on any current credit should give you a good idea of what could be gained through consolidation. If you’ve borrowed heavily on a credit card, store card or through your current account overdraft, for example, the chances are you’ll be paying heavily for the privilege.

Cards can typically charge around 20% a year, while overdrafts are likely to add penalty or admin fees to already expensive rates. Borrowing such as a student loan or mortgage, on the other hand, is likely to carry much lower rates so there may be less need for consolidation here.

Step 2: Find out the rate for a new loan

When consolidating, you borrow a sum from a new lender in order to pay off other, more expensive debts. So the next step is to find out the rate at which you might be able to borrow.

Borrowing via a personal loan has a number of advantages over cards and overdrafts in particular: not only are rates usually lower, but they are also fixed for the lifetime of the loan so you know exactly how much you have to pay back each month and for how long.

Use a calculator, such as Zopa’s, to see what these figures are likely to be, and then compare that with your present monthly interest bill. And remember, the higher the interest rate you’re currently paying, the longer it will take you to clear that debt – unless of course you decide to consolidate.

Step 3: Give yourself a deadline

With a personal loan, you can alter the level of your repayments by changing the term of the loan, so by extending it to five years rather than three, for example, you could cut the size of your monthly interest bill. Bear in mind, though, that the longer you have the loan, the greater the level of total interest you’ll end up paying.

Make sure also that you check the rate that applies to borrowing over different periods of time: loans over two or three years can sometimes charge less annual interest than five-year deals, or vice-versa.

Step 4: Check your limit

Once you’ve carried out these steps, you’ll have a pretty good idea of how much better off you could be by consolidating – so all that remains is for you to apply for a loan. You’ll then find out whether you are allowed to borrow enough to consolidate all your debts: there is likely to be a limit on the size of the personal loan you can take out. But even if this is not sufficient to pay off every last £1 of debt, you will most likely still see some benefit from consolidating even a part of your present card or overdraft borrowing.

Find out more about a Zopa debt consolidation loan.

Category: Borrowing
Tags: debt consolidation

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