Debt consolidation can help reduce your interest rate and fees by combining your existing loans and debts into one. Avoid the stress of dealing with multiple rates and fees so you can focus on paying off your debt more quickly.
How does consolidating debt with a personal loan work?
Debt consolidation allows you to combine all your loans 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 to worry about rather than several.
A debt consolidation loan offers reduced 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.
There are two types of debt consolidation: good credit debt consolidation and bad credit debt consolidation. The former involves you taking out an unsecured personal loan or balance transfer credit card to consolidate multiple credit accounts, while the latter may involve you taking out a debt agreement, which is a form of bankruptcy.
While debt consolidation is a good option for some, it may not be right for everyone. So, when should you be considering 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 a low-interest credit card with available credit. A balance transfer credit card might be an option to consider. These cards let you pay 0% p.a. for a set period for balances transferred. A debt consolidation loan could be considered for higher credit card debt or if you want to consolidate a range of different credit types.
If you have equity in your home. In this scenario, the interest rate your home loan attracts is considerably lower than that of a personal loan or credit card, so debt consolidation may be a viable option for you to consider.
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; although keep in mind some of these might be debt agreements which are a form of bankruptcy.
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.
Store/charge cards. Balances can easily increase on store and charge 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. This can include private loans, debts to utility companies (for example, electricity, phone, Sky). Look into what the credit provider will allow you to consolidate.
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:
Calculate how much you need to borrow to cover your debts. This should include any fees or charges you will have to cover in order to pay off your existing debts early.
Research and compare personal loan products to find one that meets your needs.
Apply for the personal loan.
Use the funds to pay off your other debts, along with any fees or charges.
Continue to make repayments on your personal loan until it has been repaid.
Case study
Gary is a 28-year-old labourer. He currently owes $5,000 on his credit card and still has $3,000 to pay off on the car loan he took out four years ago. He has an interest rate of 19.99% p.a. on his credit card and 9.1% p.a. on his car loan, but is struggling to juggle his repayments.
He has found a personal loan that will let him borrow $8,500 with a rate of 7.7% p.a. He decides to take out the loan and uses the funds to pay off his credit card and car loan, as well as the fees and charges for paying off his loan early.
Instead of having to manage multiple repayments at higher rates, Gary now just makes one repayment at a rate of 7.7% p.a., saving him both time and money.
How to compare debt consolidation loans
Ensure you are able to meet the requirements for a debt consolidation loan before you apply. Take into account the additional fees and charges you may have to pay, especially if you have existing fixed rate loans.
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 the form of interest. Consolidating debt can also lead to more available credit on your hands, which can, in turn, result in more debt.
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.
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.
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
Pros
Lower your repayments The majority of people who opt for debt consolidation do so in order to save on ongoing costs.
No more phone calls from debt collectors If you are falling behind with payments you probably receive a number of pesky phone calls from people chasing you for money. Once you consolidate all your loans, the phone calls will more than likely stop.
You could avoid bankruptcy If you are struggling to make multiple payments and think you might be headed for bankruptcy, consolidating your debt can give you a chance to get back on track.
Cons
You could lose your property to foreclosure If you get a debt consolidation mortgage and fail to make timely payments, you give the lender the right to foreclose on your property. The lender uses your property as collateral towards the amount you borrow; so if you fail to make repayments you stand to lose the property in question.
Increasing debt There are instances when people who opt for debt consolidation end up increasing their debt. For example, if you consolidate your credit card balances through a debt consolidation mortgage, you may start racking up further debt on your credit cards and increase your problems.
Five 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:
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.
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.
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.
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.
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.
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.
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 will actually save money if you do consolidate.
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.
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 important 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 you are struggling with your finances, speak to your creditors as soon as possible to try and work out an affordable repayment schedule.
Facing down the barrel of financial peril is scary enough, without having to worry about the legitimacy of the company you are dealing with. As with any financial product, it is important for you to compare a wide range of products and decide whether these are right for you before applying. Use the tables above to research and compare a range of legitimate companies. As a rule of thumb, if an offer looks too good to refuse, then it probably is.
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 be able to offer you the best deal. You may want to compare your options before you apply to see how competitive their products are. Then, talk to your bank before applying to discuss your eligibility.
A debt consolidation loan is just a standard personal loan product that allows you to consolidate your current debts into one. A debt agreement is usually taken out by people with large debts 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 will have on your credit file.
If you have equity, then this is another option you have available to you, but there are some things to consider.
First off, while rates on home loans are generally much lower than on personal loans, remember these are spread across a much longer term, thirty years as compared to a five or seven-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 consider if you have a large amount of debt to consolidate or you find it is the most competitive consolidation option and will help manage your debt.
Elizabeth Barry is Finder's global fintech editor. She has written about finance for over five years and has been featured in a range of publications and media including Seven News, the ABC, Mamamia, Dynamic Business and Financy. Elizabeth has a Bachelor of Communications and a Master of Creative Writing from the University of Technology Sydney. In 2017, she received the Highly Commended award for Best New Journalist at The Lizzies. Elizabeth has found writing about innovations in financial services to be her passion (which has surprised no one more than herself).
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