What Are the Risks of a Debt Consolidation Loan?

A debt consolidation loan can be an excellent solution to the issues that can arise when you’re repaying multiple debts every month. Debt consolidation basically allows you to put all your debts into one. You can ‘spread’ that debt over a longer repayment period to reduce your monthly payments. You could even find a loan with a lower interest rate.

Spreading a loan’s repayments over a longer period may mean you’ll pay more in the long term. Ask yourself whether it’s that important to save money on your monthly budget now, even if you pay back more overall.

The risks

Perhaps the biggest risk with a debt consolidation loan – as with any loan – is not keeping up with the repayments. Payment protection insurance could help if you had a significant change in circumstances that meant you could no longer make the repayments. Only certain circumstances would be covered (such as losing your job, for example).

So before taking on any kind of loan, ask yourself whether you could keep making the repayments for the length of the repayment period. Anyone already in serious financial difficulty shouldn’t borrow to repay a debt.

So if your job is seasonal, if your income varies from month to month, or if you are on a temporary contract at the moment, you could find it difficult to make regular payments.

Another risk is that you if you applied for a debt consolidation loan, but aren’t approved, your credit file would reflect this, and this can go against you when future lenders are deciding whether to lend you money.

To find more information about the advantages and disadvantages of a debt consolidation loan, this article may be useful.

Secured and unsecured debt consolidation

If you take out a secured debt consolidation loan, you borrow against the equity in your home and use that equity to repay your debts. If you didn’t keep making the repayments, the worst-case scenario is that you could eventually lose your home.

Unsecured debt consolidation loans (loans not secured against your property) carry less risk but generally have a higher interest rate. That means you could pay more overall, but there is no direct risk of your home being repossessed.

Using willpower when consolidating debts

You are opening yourself up to further risk if you continue to borrow after taking out a debt consolidation loan. If you continue spending on credit cards or taking out loans after you have paid off all your original debts with one loan, you could end up in a debt cycle (having to keep on borrowing money to repay debts).

Having said that, your debt consolidation loan could help you reduce your monthly payments – so you could find it makes it easier to get by without borrowing any more.

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