What is debt consolidation and how does it work?

24 May2011

By consolidating your debts - grouping them together - you will end up with only one debt to look after. This can make it much easier to work your debt repayments into your monthly budget, and having just one lender and one interest rate can also make things a lot simpler.

Methods of debt consolidation

There are various ways to consolidate debt. Here are a couple of the most common methods.

With a loan

A lot of the time, when people talk about `debt consolidation`, they`re actually referring to a debt consolidation loan. This is a loan taken out to pay off existing debts - thereby `consolidating` those debts into one. Many people who do this also extend their repayment period to make their monthly payments smaller.

This method of debt consolidation is only suitable for people with already manageable debts. If you`re really struggling, the difference in your monthly payments probably wouldn`t be big enough to make a real difference, and you may be better off discussing a different debt solution with an expert debt adviser.

Also remember that extending your repayment period could cost you more overall, as you`ll be paying interest for longer. Finally, as with any loan, you shouldn`t take out a consolidation loan unless you`re sure you can repay it.

Debt consolidation with a credit card

For debts that you intend to repay over a shorter timescale (i.e. in the next year or so), an interest-free credit card could be a very cost-effective option. 0% balance transfer credit cards enable you to transfer debts from other cards, and then repay the combined debt without paying interest. Given that the typical credit card rate is currently around 16-18%, this could save you a lot of money.

Just remember that these deals are time-limited - the longest deals run for up to 20 months or so - and after that time you will have to pay interest on the debt, so it`s generally only a good idea if you`re confident you can repay the debt before the interest-free period expires. After all, you`ll probably have to pay a balance transfer fee when you move your debts to a new card.

Dealing with debt problems

As we`ve discussed, the above methods of debt consolidation can`t really help with debts that are causing you problems. If you`re struggling to repay your debts, you should talk to a debt adviser about more suitable options.

There are various debt solutions that could help in this situation - a debt management plan or an IVA (Individual Voluntary Arrangement), for example. A debt adviser can help you decide which is most appropriate for your needs.

Find out more about which debt solutions could help you by taking the simple debt test below.

Try our debt solution finder

Answer a few simple questions and find out which debt solutions could help you, based on your circumstances.

Please remember, this is just an information tool. We would always recommend you speak to a debt advisor for the most appropriate way to resolve your debt problems.

We'll give you an on-screen recommendation and call you. One of our advisors will be in touch to answer any questions you may have about your results.

Your privacy is important to us. All correspondence is held in the strictest confidence and we will only request information required to find your debt solution.

Related resources:

Tags: debt, debt solutions, debt consolidation, credit card debt consolidation, debt consolidation loan, credit card, interest, 0 balance transfer, IVA