Is It Better to Consolidate Debt or Pay It Off Separately?

When you are juggling multiple debts, it becomes challenging to handle all of them separately. Consolidation seems to be the best bet then, but before you lunge at an offer, you should carefully examine whether this option is actually as favourable as it seems.

What is called a consolidation loan? 

A consolidation loan means combining all your existing outstanding debts into one large loan. For instance, you have the following debts: 

• Bad credit loans - £1,500 
• Emergency loans - £700 
• Payday loans - £800 

You will take out a new personal loan of £3,000 and use it to pay off all your existing debts. A personal loan will make it a bit more manageable, as you will be paying it down over an extended period.  

Do not be under the impression that consolidation reduces the debt amount, nor should you be holding the view that you can have all small loans consolidated. It completely hinges on the lender on how much money they will consolidate. It means you might have to handle it on your own.  

Now the question is whether you should consolidate debts or pay them off individually. There is no single situation which enables you to choose one over another. You will have to carefully assess your financial situation and calculate the cost of both options to decide on.  

When does it make sense to consolidate debts? 

Consolidation is really helpful when you owe a lot of money and are struggling to keep up with payments. The problem with small loans is that they are to be discharged in one fell swoop. Failing payments means rolling over the debt, which continues to pile up. In order to deal with this problem, consolidation would be the most favourable option for you, but your credit score must be excellent.  

Some lenders might provide you with a debt consolidation loan for a poor credit history, but they will restrict the loan amount. It is most likely that you will end up handling a large portion of your debt separately.  

Consolidation is a better option: 

When your credit score is stellar 

You should try to consolidate your loan if you suspect that you will fall behind on payments. Make sure that you contact your lender before falling behind on the payment. Once your credit score is damaged, your chances steeply plummet to get approval.  

You can qualify for lower interest rates 

Consolidation could prove to be an ideal choice if it helps lower your interest rates. Personal loans are less expensive than lump-sum loans. Another reason that makes them affordable is that payments are made in fixed instalments. Short-term loans are paid in a lump sum, and if you fail to adhere to the payment, the loan will be rolled over. As a result, the debt will accumulate too soon.  

Compared to the total cost of outstanding short-term loans, you will find personal loans much cheaper. Compare the cost of both ways of debt settlement and choose a consolidation loan only when it helps save on interest. 

If your lender has not consolidated all outstanding loans, the rest will have to be handled separately. You should still carefully check whether this option helps save some money on interest as compared to paying all debts individually.  

You can avail yourself of lower monthly payments 

Personal loans are considered affordable because they involve small monthly payments, but it depends on the repayment length and the size of the loan. Sometimes, lenders do not offer a longer repayment period. It means the size of the monthly instalments will be large. It is likely that your budget does not have wiggle room to continue to pay off the debt.  

When should you try to pay off your debts separately? 

Not all the time is consolidation the best option. Sometimes, it is safer to choose to repay your debts individually rather than consolidating them. Here is when you might want to opt for this option: 

Fees and associated charges are quite high 

Consolidation is not cheap. You will have to pay fees. It could be several thousand pounds, depending on the loan size. If you choose a balance transfer card, the transfer fees will be between 1% and 5%. If you choose to consolidate your debts through a broker, you might have to pay brokerage fees between 5% and 7% of the loan amount.  

Sometimes, when you add all these fees and associated charges, you eventually realise that you are not saving any interest at all.  

Despite consolidation, you still have many debts to tackle alone 

Most people are under the impression that consolidation loans come with a larger amount of money. The fact is that lenders do not lend even £1,000 for consolidation. It means most of the debts you will have to settle on your own. There is no point in paying consolidating fees when they do not help with payments.  

If you do not want to turn over a new leaf 

Remember that consolidating does not reduce the size of the debt. It only replaces multiple debts with a personal loan. You will have to identify the cause of crippling debt. If you do not change your spending behaviour or you do not introduce a financial discipline, consolidation will worsen your financial condition. 

Your credit score is bad 

Subprime borrowers struggle to get the nod for a consolidation loan. Most lenders turn down applications from bad credit borrowers. However, there are some who accept but charge high interest rates. If your credit rating is bad, consolidation loans will not help you save money.

The final word 

Consolidation cannot be the right choice in all circumstances. You should carefully analyse the total cost of both options. If you cannot make a decision confidently, you should consult a financial expert. They would help you arrive at a decision.  

No matter whether you consolidate or pay off debts individually, you should ensure that you do not rack up debts again.