The Pros And Cons Of Debt Consolidation Loans: A Complete Analysis

In fiscal terms, a debt consolidation loan lets borrowers pay multiple debts, including store card loans, credit cards, and personal loans. Moreover, it overdrafts into one new loan. As a result, the repayment gets consolidated into a single monthly payment. 

While debt consolidation loans provide some advantages, like lower interest rates and simplified tracking, they also come with drawbacks to consider. Understanding the full range of pros and cons is essential for determining if a consolidation loan is the right debt payoff solution for your specific financial situation.

The Top Pros Of Utilising Debt Consolidation Loans

1. The Convenience Of A Single Monthly Payment

One of the biggest appeals of a consolidation loan is it combines obligations across numerous accounts into one easy-to-track monthly bill. This avoids the headache of logging into six different credit card accounts to make payments individually with six different due dates.

With a consolidation loan, everything is streamlined into a single payment amount on the same date each month. Setting up autopay on the new loan provides peace of mind for on-time repayment since there’s only one payment to schedule.

2. Substantially Lower Interest Costs

Most credit cards carry variable interest rates ranging from 18-30%, with averages around 22%. Personal loans and overdraft fees also charge high double-digit rates. A personal loan provider protects a consolidation loan. Hence, peer-to-peer lending platforms or dedicated services are most likely to feature a relatively lower fixed rate.

For borrowers with quality credit (660+ scores), it’s possible to acquire consolidation loan rates that are lower than 4-6% APR. But even those with average credit, an individual can qualify for a consolidation loan. However, the rates are somewhere around 10-15%, which is still far lower than what credit cards charge.

By rolling overdrafts, payday loan balances and high-interest credit cards onto a consolidation loan with a reduced rate, borrowers pay significantly less interest more than a 2-5-year repayment term.

For example, £20,000 in credit card debt at 22% would cost over £5,200 a year in interest. The same amount at 15% costs around £3,000 annually. That’s £2,200 yearly savings from a lower consolidation loan rate.

3. Increased Available Cash Flow

Along with decreased interest costs, consolidation loans free up cash flow by extending the repayment period from a typical 2-3 years for credit cards to 5-7 years on a consolidation loan. While a longer term means paying greater total interest over time, the benefit is a lower individual monthly payment.

This newly opened-up disposable income might be deployed toward knocking down the consolidation loan principal at an accelerated pace. Even paying only an additional £50-100 monthly above the required payment quickly shrinks a loan down faster through the power of compound interest.

4. Potential For Credit Score Improvement

Responsible repayment of a consolidation loan over an extended period demonstrates positive financial behaviors. Making consistent on-time monthly payments can gradually help improve your credit score over time as the loan builds an additional positive history.

Of course, taking out the loan itself may cause a small initial score drop from issues like credit mix changes or a hard credit check. However, avoiding late payments and continuing to keep credit card balances low prevents further score erosion.

5. Halts Collections Efforts And Creditor Harassment

For accounts severely behind on payments, debt consolidation brings them current and stops collection agencies from pursuing debts. This provides immediate relief from the stress of constant collection calls.

Additionally, consolidating payday loans or other short-term lending removes debt traps where rollover fees pile on and multiply an account out of control. Bringing these balances under the fixed repayment structure of a consolidation plan ends the cycle.

The Primary Cons To Keep In Mind

1. Consolidation Loan Rejection Risk

Based on factors like your income-to-debt ratio, existing debts, and credit rating, lenders may deny your application for a consolidation loan. Those with very poor credit face the highest rejection likelihood.

Having significant negative marks like bankruptcies, foreclosures, or liens on your credit reports also hurts approval odds and means only subprime lenders may work with your application.

2. Lengthy Repayment Period

A major trade-off of consolidation loans is they stretch out the repayment timeline significantly through terms of 5-7 years. While beneficial for managing monthly costs, paying off debts over so many years means paying substantially more interest over the full loan term.

Consolidating $15,000 in credit cards with 18% APRs over 5 years means shelling out over $5,000 in interest payments versus just $2,300 over 2 years. However the monthly cost savings may make this cost justifiable depending on your situation.

3. Potential Upfront Origination Or Admin Fees

Some lenders charge upfront fees for processing and issuing a consolidation loan. These can reach 1-5% of the total loan amount. Such fees essentially add to the total interest costs and reduce net savings from consolidation.

Watch for these, and know that not all lenders charge them, especially for borrowers with great credit. Shopping and comparing loan offers helps avoid fees.

4. Credit Score Dip

The immediate impact of opening a new account and hard credit check inquiry may cause a small temporary drop in your credit score. However, as noted above, responsible ongoing usage can offset this through score recovery within 6-12 months.

5. Impact on Your Credit Mix

Part of your credit score factors in a healthy mix of accounts like revolving credit lines (credit cards) and installment loans (mortgage, auto, personal loans). Consolidating multiple revolving accounts into a single installment loan negatively alters that distribution, which can also slightly hurt scores.

Key Considerations In Assessing If Debt Consolidation Loans Is Right For You

A. Carefully Calculate Interest Savings

Tally up current debts and associated interest to be paid over your current multi-year repayment term, along with fees, to determine total costs. Compare this to total interest and fees from a prospective consolidation loan over its multi-year term. This calculates true savings.

B. Think About Your Financial Discipline

Consolidation loans only accelerate repayment if you stick to your monthly budget during the loan period and avoid accruing new debts. If you lack discipline, consolidation may backfire. Consistently making extra principal payments is key.

C. Check Impacts on Your Credit Score

While the short-term score dip from a new inquiry and account is usually minor, also consider whether monthly on-time consolidation loan payments can demonstrate financial responsibility and help scores going forward.

D. Evaluate Your Current Debt Payoff Trajectory

If current debts are already clearly on track for timely and affordable elimination through minimum payments, consolidation may be unnecessary. But if juggling minimums across accounts with varying rising interest rates feels unmanageable, consolidation simplifies.

E. Assess Other Options Like Balance Transfers

Sometimes alternatives like balance transfer cards offer 0% intro APR periods to eliminate debts faster over 12-15 months. Run numbers against consolidation loans for the best fit.

Carefully weighing consolidation loan pros and cons based on your personal financial behaviors, debts, income, credit rating, and repayment time horizon determines if consolidation is beneficial for your situation.

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