Should You Take a Loan to Pay Off Debt?

How a consolidation loan works

A debt consolidation loan is a new loan used to pay off several existing debts, such as credit cardsHow Credit Cards Work in the UKHow UK credit cards work: interest, APR, minimum payments, interest-free periods, fees, Section 75 protection and how to use a card without getting into debt.Read more →, overdraftsOverdrafts Explained: Costs, Rules and AlternativesHow UK overdrafts work: arranged and unarranged, how interest is charged, the effect on credit files, the risks and cheaper alternatives to borrowing.Read more → and other loans. You then repay the new loan in fixed monthly instalments. Done well, it can reduce the rate you pay, simplify your payments and give you a clear end date. Done badly, it can increase the total cost, tempt you to run up the cleared cards again or put your home at risk. Our guide to debt consolidation covers the options.

When it can make sense

A loan may help if all of these are true.

1. You can afford the monthly payments comfortably, even if your income dips.
2. The interest rate is clearly lower than what you pay now, including fees.
3. The total you will repay is lower, not just the monthly payment.
4. You can resist using the cleared credit again.
5. Your credit record is good enough to qualify for a competitive rate.

The risks

• Longer term, higher total cost: A lower monthly payment can come from stretching the loan over more years, which can mean paying more in interest overall.
• Fees: Arrangement fees, early repayment charges on old loans and broker fees can eat the saving.
• Secured loans: If the loan is secured on your home, you could lose it if you cannot pay. Your home may be repossessed if you do not keep up repayments on a mortgage or other loan secured on it.
• New debt on top: If you clear cards and then spend on them again, you end up with the loan and new card debt.
• Poor credit lenders: High-cost lenders and brokers who target people in difficulty may charge very high rates.

Unsecured versus secured

If a loan is secured on your home, speak to a free adviser before signing. Converting unsecured debtsUnsecured debtAn unsecured debt is borrowing that is not tied to an asset, so the lender cannot automatically take your home or car if you do not repay.Read more → into secured debtSecured debtA secured debt is borrowing that is tied to an asset, usually your home, which the lender can sell if you do not keep up the repayments.Read more → gives creditorsHow to Deal with Creditors: Communication and NegotiationPractical advice on communicating with creditors, negotiating affordable repayments, and understanding your rights when dealing with the companies you owe.Read more → stronger rights and may mean you lose protections you would otherwise have.

What to check before you apply

1. The APR and total cost, not just the monthly payment
2. The term and how it compares to what you pay now
3. Early repayment charges on the debts you are clearing
4. Whether you are eligible, using a soft-search eligibility checker so you do not harm your credit file
5. Whether the lender is authorised by the Financial Conduct Authority

Alternatives to try first

• A 0% balance transfer card, if you qualify and can clear the balance within the offer period. See balance transfers explained.
• Negotiating with creditors for lower interest or smaller payments. See how to deal with creditors.
• A debt management plan, set up for free by a charity, if you cannot afford your debts. See debt management plans.
• Paying down debts using avalanche or snowball. See how to pay off debt faster.
• A formal solution such as a Debt Relief Order or IVA if the debts are unaffordable. See IVA vs DMP vs DRO vs bankruptcy.

Loans and credit file

Applying for a loan leaves a record on your credit fileHow Credit Scores Work in the UKHow UK credit scores work: what the credit reference agencies record, what affects your score, why scores differ between agencies and what lenders actually see.Read more →, and several applications in a short period can harm your score. Missing payments on the new loan damages it further. Use eligibility checkers before applying. See how credit scores work.

Get free advice first

If your debts feel unmanageable, speak to a free adviser before borrowing. They can tell you whether a loan makes sense, whether you would be better off with a free plan or a formal solution and how to avoid costly mistakes. See free debt advice in the UK and financial adviser for debt.

A worked example

Imagine you owe £8,000 across three cards at around 24% APR. A personal loan at 11% APR over four years would reduce your interest cost and give you one payment. But if you took the same loan over seven years to get the lowest payment, you might pay more in total than a four-year version. And if you then ran the cards back up, you would owe more than before. The loan helps only if you pick the right term, keep the cards at zero and can afford the payment every month. The figures here are illustrative, but the pattern is common.

Warning signs of a bad deal

Walk away if the lender takes fees upfront, will not give you the total cost in writing, pressures you to sign quickly, offers a rate that seems too good to be true for your credit record or wants to secure the loan on your home without explaining the risks.