Dealing with debt can be daunting. If you’re struggling to keep track of which store account to pay next and weighing up which credit card is more important to settle first, you may have considered debt consolation.
At JustMoney, we’ve decided to get down to the basics and explain what this entails and what impact you can anticipate on your credit score.
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Debt consolidation and its benefits
According to James Williams, head of marketing at short-term lender Wonga SA, debt consolidation involves taking out one large loan to pay off several smaller loans.
“Instead of paying off a number of separate loans each month – such as a credit card, store cards, and short-term loans – the borrower will only owe money to one credit provider,” says Williams.
He points out that consolidation loans should ideally have a lower interest rate compared to the debts you would like to settle.
“A generally-lower interest rate and extended payment period should result in lower monthly payments, making debt consolidation a good option in some cases,” says Williams.
“The monthly instalment associated with a consolidation loan should be less than the combined total of the smaller debt instalments,” he notes.
Who should consolidate their debt?
Williams notes that if a consumer is struggling to keep up with their monthly debt repayments, a consolidation loan could be for them.
“Late or missed loan repayments can have a negative impact on your credit score, making it hard for you to access credit in the future,” says Williams.
“Keeping track of debt can be a lot simpler when only one payment is required at the end of each month. Therefore, the financial burden of debt is easier to manage,” he explains.
The downside of debt consolidation is that the extended repayment term can actually end up costing more in total. Williams therefore suggests that debtors should try to pay off these loans as quickly as possible.
What’s the impact on your credit score?
Consolidating your debt can in fact have a positive impact on your credit score, and the simple act of taking out a consolidation loan will not affect it negatively.
“By making these monthly payments both easier and more affordable, a consolidation loan can help borrowers maintain a good credit profile and improve their credit score in the long term,” says Williams.
However, he cautions, if you are not in control of your spending, this type of loan can have the opposite effect.
“Once credit cards, store cards, and short-term loans are paid off, the borrower will have access to these facilities and can wrack up even more debt,” he says.
He notes that the added financial burden can make it difficult for applicants to make monthly debt repayments, causing them to become overindebted and impairing their credit rating.
“Therefore, this option should only be used by people who are committed to taking control of their money and paying off their debts, rather than people who want to free up more spending money,” says Williams.