An introduction to debt consolidation

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The financial history of any consumer dictates something known as a credit rating. A credit rating is used by lenders to decide whether a consumer is a 'high-risk' or a 'low risk' borrower. This in turn affects the borrower's potential to receive good or bad rates of interest on things such as credit cards, loans and mortgages. The poorer a credit rating, the higher the rate of interest the consumer will be charged. The better a credit rating, the lower those rates of interest will be.

A credit rating is a reflection of a borrower's ability to make payments on almost any financial commitment - from credit payments to mortgage fees. As a borrower struggles with escalating debt and become less able to make repayments their credit score is likely to suffer accordingly. Thus the spiral of debt becomes hard to escape.

It is possible to improve a bad credit score with astute financial planning, the aim being to honor all outstanding debs. If their credit rating is affected positively the borrower represents less of a risk to lenders, consequently the chance of lower-interest rate borrowing is improved. Many homeowners use the equity in their houses to consolidate and pay off their debts, consequently improving their credit score and, hopefully, making life easier in the future. They do this using either secured loans or unsecured loans.

Secured loans are directly related to a borrower’s home. The lender 'secures' the loan against the borrower's house meaning that, in the event of the borrower being unable meet repayments, the house can be forcibly sold and the lender can reclaim the loan from the price that the house is sold for.

This type of loan is cheaper to manage than an unsecured loan, because the loan is secured. It is also possible to borrow larger amounts when using your house as collateral, the potential also exists for the consumer to borrow the money over a considerable length of time e.g. 20 years. Thus, the interest rates attached to this form of loan are comparatively low (Secured Loans from Asda Finance for instance can be stretched over 240 months at an APR of 7.6% meaning you’d pay £795.76 a month - £191,277.40 in total - on a £100,000 loan). However, the risk of repossession is not one to be taken lightly.

Conversely, the risk associated with unsecured loans is increased for the lender because the loan isn't secured against the borrower's home. As a consequence, lenders tend to offer substantially higher rates of interest, the length of the loan is likely to be limited to a shorter term and less money made available. There is also a minimal risk that the house can be repossessed in rare circumstances, although, statistically, this is extremely unusual.

If you are thinking about a loan it's a good idea to try using a Loan calculator like the one on the A&L loans website, there will be something similar on most loan provider's websites. They should help you to work out how much you can actually afford to borrow and what sort of repayment arrangement would best suit your situation.

Before deciding on either of these paths it is worth contacting a Debt Counseling Service. If you're struggling with debts these services offer invaluable free advice and try to manage the situation so that someone in debt and/or with a poor credit history can try and consolidate their debts without risking their home.

If you’re worried about spiraling credit card debt you should consider switching your balance to a new card, look out for good balance transfer rates - there are currently plenty of 0% on balance transfer cards on the market - the RBS credit card offers a particularly good deal with 0% on balance transfers for 13 months, a 2% balance transfer fee and 0% on purchases for 3 months. For an up to date overview of the best offers it's a good idea to check out one of the many credit card comparison sites like uSwitch or the Motley Fool credit cards centre.


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