Consolidation Loans
What is a Consolidation Loan?
A consolidation loan, as its name suggests, is a loan that consolidates many debts into one loan with one monthly payment. At first sight they appear attractive, because they can simplify your finances and reduce your monthly payments. They are heavily promoted in TV advertisements and sold as an easy answer to your debt problems. As well as "paying off all your debts", they often show that you can also have a family holiday or buy that new car you've always wanted. It almost sounds too good to be true doesn't it? While they do have their place, more often or not they are bad news. We explain why below.
Why Consolidation Loans are usually bad news
- Consolidation loans do not "pay off your debts", they move your debt from one place to another
- If you use your consolidation loan to fund the purchase of a holiday or a new car, you are actually making your debts bigger, not smaller!
- Although a consolidation loan may reduce your monthly payment amount, it does this by spreading the debt repayments over a much longer term. So you will pay a great deal more in interest and be in debt for much longer.
- A consolidation loan is often used as a quick fix, without the borrower taking the time out to fix the underlying problem. If you don't address the underlying problem, then you will get further and further into debt on top of the consolidation loan. In a poll on The Motley Fool financial website, more than 90% of borrowers who took out a consolidation loan got themselves into further financial difficulty because of this. This is another important part of the "lightbulb moment" - when it dawns on you that you can not borrow your way out of debt. The only way that you can get out of debt is to spend less than your income and use that surplus to pay off your debts. That last sentence is worth reading twice - it is very important!
- One of the most important reasons for being wary of consolidation loans is that they usually convert unsecured debts into a secured debt. In short, that means that you are moving debt to a type of loan that puts your home at risk. For a more detailed explanation of the difference between secured and unsecured debts, read our Guide to Problem Debts.