Debt consolidation loans

Do you have multiple debts that you are struggling to keep on top of? A debt consolidation loan can help reduce the interest and fees you need to pay by combining your existing loans and debts into one.

How does consolidating debt with a personal loan work?

Debt consolidation allows you to combine all your loans, credit card debt and store card debt into one. Essentially, it can give you a way to reduce your interest rates and fees, thereby giving you a way to get yourself out of debt. If you choose to consolidate your debt, you’ll have one loan repayment and one lender to deal with, rather than several.

A debt consolidation loan may help you save on interest and fees, but it’s important to also consider refinancing costs and early payout fees from your existing loans to see if the cost of consolidating is more than the money you’ll save.

People normally take this road to minimise their ongoing expenditure and make their credit more manageable. For example, if you owe $2,000 on your credit card, $2,000 on a store card and $6,000 on a personal loan, you could look for a debt consolidation loan of $10,000. As well as leaving you with a single repayment, you no longer have to deal with different interest rates and multiple fees, so it can also lead to savings in this way.

When should I consider debt consolidation?

• If you have trouble keeping up with monthly repayments. In this case, debt consolidation can reduce the number of repayments and simplify the management of your debt. This is especially true if you are nearing the credit limit of your cards or you have already reached the limit.
• If you have bad credit and a large amount of debt. You can consider a debt consolidation loan in order to take back control of your finances. There are some loan companies that specialise in bad credit debt consolidation loans.
• If you want to get out of debt faster. By reducing the amount of interest and fees you pay with multiple debts, you can get out of debt faster.
• If you want to improve your credit report. Having multiple unpaid debts on your credit report will not do you any favours for future loan applications. It isn’t a good idea to apply for further finance if you are already struggling to keep up with payments. Paying off some of the debts helps improve your credit rating and you have a lower chance of defaulting on payments.

What debt can I consolidate?

It is possible to consolidate a variety of debt using one of these loans. Common types of debt that are consolidated include the following:

• Personal loans. This is a common type of debt to consolidate. You can take out a debt consolidation loan to:
  • consolidate two or more separate personal loans
  • a personal loan and another type of credit
  • or even refinance a personal loan to one with a lower rate and/or fees.
• Credit cards. If you have a large outstanding balance due on your credit card, you can consider taking out a personal loan to pay it off. This is often an option when you want to consolidate your credit card with another debt or you aren’t a candidate for a balance transfer credit card.
• Store credit cards. Balances can easily increase on store credit cards, as they do on credit cards, making them another type of debt people choose to consolidate.
• Other credit accounts. Depending on the loan you take out, you may also be able to consolidate other types of debt. Look into what the credit provider will allow you to consolidate. Some types can include:
  • private loans
  • debts for utilities, such as home energy bills
  • your mobile phone plan or
  • Sky.

5 steps to consolidating your debt with a personal loan

Once you have decided to consolidate your debt, you will need to do the following:

1. Calculate how much you need to borrow to cover your debts. This should include any fees or charges to pay off your existing debts early.
2. Research and compare personal loan products to find one that meets your needs.
3. Apply for the personal loan.
4. Use the funds to pay off your other debts, along with any fees or charges.
5. Continue to make repayments on your personal loan until it has been repaid.

How to compare debt consolidation loans

• Affordability

  Ensure you are able to meet the requirements for a debt consolidation loan before you apply.

  Choose the term of the new loan with care, because while longer terms could result in lower repayments, you could end up paying more in interest. Consolidating debt can also lead to more available credit on your hands, which can result in more debt if you are not careful.

• Comparing costs, interest rates and loan term

  Before signing on the dotted line it is crucial you know exactly how much you have to pay. This includes the interest rates, fees and costs. If this is not lower than what you pay on your existing loans, opting for a debt consolidation loan might not be a good idea after all. This process requires you to add up all the costs of your existing loans, including exit costs, and compare these with the costs linked to getting a new loan.

  Paying attention to the loan term is important because if you opt to pay a short-term loan with a high-interest rate, over a longer-term through a lower interest alternative, you could still end up paying more in the long run.

• Early repayment costs

  Some lenders charge repayment penalties if you pay your loan off earlier than agreed. Check to see if your current lender charges early repayment penalties or payout fees and if this will still help you save when you take out the debt consolidation loan.

• Licensing

  If you decide to use the services of a credit provider or a debt consolidation organisation, it is your responsibility to check for its licensing with the Financial Markets Authority (New Zealand). This is because there are brokers and credit providers who operate illegally in New Zealand.

Pros and cons of debt consolidation

Six tips for debt consolidation

While taking out a debt consolidation loan can help you reduce the interest you pay and better manage your repayments, it is up to you to make the most of your debt consolidation efforts. The following are some useful tips to help your debt consolidation loan work best for you:

1. Work out a debt management plan. If you are in a position where you need to enter a debt agreement with your creditors, it is important you agree to a plan that is manageable. These agreements are informal and can be worked out between you and your credit provider. If you choose to take out a debt consolidation loan, make sure the debt management plan you enter into is the right choice for you.
2. Use a budget. Budgeting your debt consolidation repayments ensures they remain manageable over the term of the loan. How much do you need to pay each month to ensure your debt is paid off? Work your loan repayments into your budget before you take out the loan.
3. Compare your options. Make sure you take a look at all the options available to you before you apply for a debt consolidation loan. Are you applying for the most competitive option available? Ensure you look at fees as well as rates and any additional features you may have access to, to see if you are getting the best deal for you.
4. Make extra repayments. If your loan allows for it, making additional repayments can help see your loan paid off sooner and save interest. Make sure you won’t be charged fees for additional repayments, lump-sum payments or early repayment penalties depending on how you plan to repay your loan. If you find you save a considerable amount on interest from consolidating your debt, make sure to put this saving back into your loan.
5. Look for ways to cut down on your expenditure. Are there any ways you can cut down on your outgoings? By cutting down your expenditure you will have more money to make additional repayments, the benefits of which are explained above. Ensure you are in a safe position to manage your repayments and pay back your debts.
6. Cut up your credit cards and close accounts. Continuing to use credit cards that have been paid off with a debt consolidation loan is one big mistake that people make. Once the card has been paid off, close the account and cut the card up so you are not tempted to use it.

Frequently asked questions

The debt consolidation road map can be tricky to navigate and you may not get all the answers you need from your bank or financial planner.

• Is debt consolidation right for me?

  As outlined previously, there are a few different situations that might make debt consolidation the right option. However, before you take out a debt consolidation loan, work out what your current monthly repayments are, as well as the interest rates you are paying. Then you can consider the options you have available for debt consolidation and see if you can actually save money if you do consolidate.

• Can I consolidate more than one credit card?

  If you have more than one credit card from different institutions, you might be finding it hard to manage your interest repayments. By combining your existing debt into a new consolidation loan, you could lower your repayments and pay less interest. For example, if you have one credit card with a $6,400 at 19.99% p.a., another with $1,000 at 13.49% p.a. and an “interest-free” store card, these can all be consolidated into a new loan.

• I receive Work and Income payments - can I still apply for debt consolidation?

  Work and Income payments may be classed as genuine income by some lenders and can be used to assess your serviceability for a debt consolidation loan. It is essential to calculate your repayments and find out if your lender accepts your types of income. If you are currently receiving Jobseeker’s Support or Youth Payments and are struggling with your finances, speak to your creditors as soon as possible to try and work out an affordable repayment schedule.

• My current bank offers a debt consolidation loan. Should I just apply with them?

  There are some definite advantages to applying with your current bank. They may be more willing to approve your loan because they have a past relationship with you and they can see all your incomings and outgoings. Then again, they may not offer you the best deal. You should compare your options before you apply to see how competitive their products are. Then, talk to your bank to discuss your eligibility.

• What's the difference between debt consolidation and a debt agreement?

  A debt consolidation loan is just a standard personal loan product that allows you to consolidate your current debt into one. A debt agreement is usually taken out by people with large debt or even a bad credit history and is a form of bankruptcy. Make sure you find out the terms of the loan you are entering into and the effect it may have on your credit file.

• I have some equity in my home. Should I refinance and consolidate my debts that way?

  If you have equity, then this is another option available to you, but there are some things to consider.

  Firstly, while rates on home loans are typically much lower than those on personal loans, remember these are spread across a much longer-term, 30 years compared to a 5- or 7-year term. You also need to consider the costs of refinancing before you take on this kind of loan. This option might be good to look at if you have a large amount of debt to consolidate or you find it is the most competitive consolidation option and it helps manage your debt.