What is Debt Consolidation and Will it Affect My Credit Score?

Did you know that as of April 2022, the average UK adult had nearly £4,000 in debt? If you’re in the same boat, you know that carrying debt can be stressful. Plus, with interest rates rising and budgets across the UK tightening, you might be looking for a new way to manage your debt.

You may have heard of debt consolidation and might even be considering it as a method to manage your debt. Debt consolidation can be effective for some people, while only aggravating debt problems for others. In this blog, we’ll tell you all you need to know about debt consolidation and how it impacts your credit score, and how to know if it might be right for you.

What is Debt Consolidation?

Debt consolidation is a method of consolidating various debts into a single payment. It typically takes the form of a loan, which is taken out to immediately repay debts from things like:

• Credit cards
• Personal loans
• Other debts like store cards or overdrafts

Once you’ve paid these debts with the debt consolidation loan, you are left paying back the one loan, rather than several different lines of credit. But why would you take out a debt consolidation loan? What benefits do they offer that make them an attractive debt management tool? Let’s take a quick look.

Benefits of Debt Consolidation

Debt consolidation loans have a number of benefits, but chief among them are the following:

• Simplified payments: If you’re struggling to keep track of multiple payments, and this is resulting in you being hit with late fees, increasing interest, or other penalties, a debt consolidation loan can make it easier to keep track of your payments. This can help improve your payment history, which has a huge influence on your credit score.
• Lowered credit utilisation ratio: Debt consolidation can lower your credit utilisation ratio by combining various payments into one. This can have a positive impact on your credit score, as you won’t be using as significant a portion of your credit limit each month.
• Can have lower interest rates: If you have a strong credit score, a debt consolidation loan may come with a lower APR than what you have on other credit lines, which could help you improve your credit score. However, this won’t be available to everyone so be sure to double check this as interest rates are currently on the rise.

Related Read: Understanding Credit Utilisation

Risks of Debt Consolidation

Like many credit building tools, debt consolidation loans aren’t without their drawbacks. Let’s take a look at some of the reasons you might not want to use a debt consolidation loan:

• Long repayment terms: While your interest rate could drop if you have a strong credit score, it doesn’t guarantee that you’ll save money. This is because debt consolidation loans often have longer repayment terms than things like personal loans. Although your interest rate might be lower, it will be accruing interest for a longer period of time, costing you more in the long run and eventually damaging your credit score.
• Doesn’t change your debt habits: The simplified payments that debt consolidation loans are highly valuable to some people, as they help them make timely payments to improve their credit score. However, for others, it can create a false sense of security that leads them to fall deeper into debt, damaging their credit score even further.

Related Read: How to Use a Credit Card Wisely

Is Debt Consolidation Right For You?

So is debt consolidation right for you? It’s not always easy to tell; start by considering the pros and the cons. Does the reward outweigh the risks in your case? Additionally, you’ll want to ask yourself the following questions:

• Is my credit score good enough to get a favourable interest rate? If it’s not, debt consolidation may be no better than your current debt-repayment plan.
• Do I have the discipline to avoid taking on additional debt? If you’re not confident in your ability to avoid additional debt while repaying the debt consolidation loan, it could be a risk for your finances.
• Would another debt-repayment strategy work better for me? There are a number of different ways to get out of debt, so make sure you’re selecting the one that’s the best for your personal finances.

In short, debt consolidation loans can be incredibly helpful when used wisely and in addition to a comprehensive debt-repayment plan, but they can lead to more trouble when used as a quick fix for debt. Having a firm understanding of debt consolidation loans and your own financial circumstances will help you make the best decision.

Related Read: How to Get Out of Debt in the UK

Pave Can Help You Build Credit the Right Way

When it comes to getting out of debt and building credit, taking out a new line of credit is always a risk. Fortunately, you can build credit and stay on top of your payments without taking on additional debt.

The Pave App’s bills monitoring helps you keep track of your payments so you never miss a deadline, plus, our active credit building feature can help you improve your credit score without taking out a new loan, credit card, or anything else. Combine these incredible features with personalised credit fixes, and it’s easy to see why hundreds of thousands of Brits have turned to Pave as they embark on their credit-building journeys.

To check it out for yourself, download Pave from the App Store or Google Play today.