The good and bad sides of consolidation loans

Fool.co.uk urges consumers who take out consolidation loans to resist the temptation of running up further debt.

A poll of people who have taken out consolidation loans shows that three out of five borrowers then go on to run up further debts. The results also reveal that men and women are equally likely to accumulate more debt after they roll up multiple loans into one big debt.

While two in three people were given the option to pay off their loans early, no more than a handful succeeds - only one in four people say they manage to clear their debts early. That said, people who paid off their consolidation loans early were less likely to go on to accumulate more debt.

The poll found that whilst both the length and size of loans varied considerably, the average consolidation loan is around £16,500. Additionally, it lasts almost eight years. The average size of loans taken out by men and women are roughly similar, but twice as many men compared to women manage to pay off their loans early.

David Kuo, Head of Personal Finance at Fool.co.uk, says: “Consolidation loans aren’t necessarily a bad idea. After all, it can make sense to roll up several expensive debts into one affordable monthly payment if you are faced with a myriad of claims on your money.

“Another option is to snowball your debts. This means paying off debts with the highest rate of interest first, while making minimum payments on other loans.

“But if you do choose consolidation loans, do so carefully. For instance, around half the loans taken out by people in our survey carry a penalty for early settlement. This is unreasonable, and is unlikely to encourage borrowers to pay off their loans sooner.

“It is also vital to use consolidation loans sensibly, given that those newly paid-off credit cards will be brought back to life with enticing and generous spending limits. It can be difficult to resist whipping them out to reward yourself, especially if you have been diligently paying off your consolidation loan month after month.

“Consolidation loans can be a welcome lifeline for people caught in financial difficulties. But the lifeline can quickly turn into a noose if you submit to the temptation of running up further debts.”

Three dos and three don’ts when taking out consolidation loans:

Do ensure the loan is flexible if you are disciplined so you can make overpayments or pay the loan off early.

Do make sure that you take out a fixed-rate loan to avoid sudden interest rate rises.

Do avoid payment protection insurance unless you're absolutely sure you need it.

Don’t borrow more than you need.

Don't put your home at risk by taking out a secured loan.

Don’t use your credit cards until you have fully paid off your consolidation loan.