What Is the Best Way To Consolidate & Pay Off My Debt?

Many want to make their finances more affordable by consolidating their current monthly outgoings. They take out a debt consolidation loan to pay off all their credit cards and loans. This reduces their monthly outgoing to one lower payment.

The benefit of a new loan is that you only have one monthly direct debit coming out of your bank account. You no longer have to worry about managing multiple direct debits for your loans and credit cards.

What Types of Debt Consolidation Loans Are There? 

Below, find some popular ways people pay off their debt today. 

1. Unsecured Loans to Pay Off Credit Cards

For smaller loan sizes, say £10,000, an unsecured loan or personal loan may be the right option. This type of loan has a benefit: you do not need to use your home as security. Therefore, if you cannot keep up with payments, you won't lose your home.

Another consideration with an unsecured personal loan is that the repayment periods are normally between one to seven years, meaning that anyone wanting to borrow a high loan amount, say £35,000 or more, would have relatively high loan repayments.

Other types of borrowing, such as homeowner loans, offer longer repayment periods. This can be up to 30 years. This means that monthly repayments may be lower and more affordable.

The amount you can borrow and the interest rate will be largely determined by your credit score. Many unsecured loan comparison sites will carry out a soft credit search to give you an indication of if you will be accepted, the amount you can borrow and the interest rate that would apply. A soft credit search does not affect your credit rating.

When you make a full loan application the credit search will be registered on your file.

2. Pay Off Debts with a Second Charge

For those looking to borrow a higher amount, say £30,000 or more, a secured loan or second mortgage might be the right choice. The longer repayment terms (up to 30 years subject to age) available mean that you could see a significant reduction in your current monthly credit commitments.

Chances are, you will pay more interest than if you kept your existing credit cards and loans. This additional interest could be significant.

The exact amount of interest you will have to pay back would be determined by the interest rate and term of the new loan.

This type of loan requires you to put your property as collateral. If you can't keep up with the monthly payments, you risk losing your home.

What Types of Second Mortgages Are There?

There are two types of a second mortgage, also known as home equity loans.

Variable Rate Products

This means that the interest rate can go up or down which means your repayment can go up or down. The variation is normally linked to any change in the Bank of England base rate. The Bank of England meets eight times a year to review interest rates.

It is difficult to budget accurately with this type of loan as you can't say for certain what your monthly repayment might be in say 6 months. 

A Fixed-Rate Product

This means that the interest rate will be fixed for a certain period regardless of changes in the Bank of England base rate. Most lenders offer fixed periods for the first 2 years, 3 years or 5 years of the loan. Some lenders offer other fixed-rate periods.

With a fixed-rate second mortgage, it is easier to budget as you know for certain what your repayment will be for the fixed period. At the end of the fixed rate period you normally have the opportunity to fix the rate for another 2, 3 years or 5 years, or switch to a variable rate product.

Market conditions at the time will have a bearing on your decision. It would be wise to seek the services of a qualified mortgage broker to get their recommendation.

One point to consider is that many lenders will charge you an early redemption charge (ERC) if you settle the loan during the fixed period. The potential ERC will be clearly shown in the mortgage offer and might be 2% or 3% of the balance outstanding when you want to settle.

There may be early redemption charges on a variable-rate product too. Again, this will be clearly shown in the mortgage offer.

Guarantor Loan To Repay Debts

Guarantor loans are for people that may not be able to get a loan themselves, perhaps because of poor credit history. To apply for a loan you need a third party such as a family member who can guarantee to make the repayments if you can’t.

Interest rates are much higher than those offered for unsecured loans and second mortgages. It is unlikely that you would benefit from using a guarantor loan to consolidate your current debts as the interest rate is likely to be much higher than the rates you are paying on your current credit commitments.

Another type of loan available is a payday loan which is a very short-term loan. However, these loans are for small amounts, typically £100 which are paid back over a very short period, like 3 months. A payday loan would not be suitable to consolidate your current debts.

How to Avoid Consolidating Your Debts

While there might be an appeal to reducing your outgoings with a debt consolidation loan, it may be better to try and manage your current commitments and continue until they are fully paid off.

Now may be a good time to look at your finances carefully to see if there are any outgoings that you could stop to help reduce your outgoings.

Do you need a second car? Could you use public transport or cycle to places? If you don’t need a car, you could sell it and pay off any finance owed. In addition, you would save monthly on fuel, servicing, insurance and parking.

Another area to make savings is to research the credit card market. You might be paying a rate above 20% on your current credit cards. Some lenders allow you to transfer your current balance over to them at a rate of 0% interest for 18 months. At the same time do not be tempted to start spending on the new credit card. You should consider using a credit card comparison site.

Speak To Your Loan Companies

Many people are struggling financially in the current cost of living crisis. Rather than take out another loan to clear your current credit you could consider approaching your current credit card and loan providers, to see if they are happy to come to some arrangement whereby perhaps you pay a reduced repayment for a 3 or 6-month period.

If you are under financial strain, it is always better to approach your current lenders before you start to miss repayments on your loans. They are likely to be more favourable to coming to some arrangement if you approach them in the first instance.

One point to consider is that any arrangement you come to with your current lenders may harm your credit score and make it more difficult to borrow at a later date. A lower credit score may mean that you couldn’t borrow as much as you wanted in the future and it’s likely to be at a higher interest rate.

If you think you could benefit from a second mortgage, why not contact The Second Mortgage Company?