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When I first decided to get my debt issues under control, one of the first things I looked at was getting a debt consolidation loan for all the various things I had on finance. The credit cards, the car, personal loans and numerous store cards I had taken out over the years and never fully paid back.
This one simple decision, simplified my life immeasurably.
In essence, debt consolidation is simply taking all of your outstanding debts and rolling them into a one. This could be in the form of a personal loan with either with one of your existing finance providers, or, a new company who specialise in consolidation loans.
Debt Consolidation Loans are popular in Australia and the market is well catered for. The major banks and specialist lending institutions are all involved in this field of finance but before you start it pays to know a few things about consolidation loans.
Will I be eligible for debt consolidation?
One thing the keep in mind, this is not a service that everyone will be able to access. Your credit file and payment history will have to be in relatively good order to qualify. A reputable finance company will not want to take you on if you have numerous missed payments on your credit file.
A good debt consolidation loan should lower your overall cost of repayments by combining your high interest rate loans (credit cards, car loans etc.) into one loan that has a lower repayment.
The most common items to be paid with a debt consolidation loan are:
- Credit cards
- Store cards
- Personal loans
- Outstanding bills
- Tax debt
Before looking into debt consolidation you will need to get a good understanding of your current situation.
- How much do you owe on each debt?
- What is the total amount you owe?
- How much interest are you paying for each debt?
- How long have you got to pay them off?
- What are the extra fees and charges you’re paying because you have multiple debts?
To give you an idea of how much you could save if you were to consolidate all of your bad credit loans into one, NAB has released this calculator to show how much you could be saving.
To give you an idea of how much you could save if you were to consolidate all of your bad credit loans into one, the NAB calculator shows how much you could be saving.
This video is a little lengthy at just over 14 minutes but provides helpful tips, skip to the 10 minute mark which is where the decent information starts.
How can I consolidate my debt?
There are three main ways to do this.
Personal Loan – These are unsecured loans and the most difficult to obtain If you already have a low credit score.
Home Equity Loan – Perhaps one of the most common ways to refinance your loans. Beware the hidden dangers, mainly that the loan will be secured against your property which will be at risk if you fail to keep up repayment! See the worked example below about home equity consolidation.
Credit Cards – This can work in LIMITED circumstances when a low “lifetime rate” balance transfer offer comes up . You move as much of your existing balance to the lower rate card as possible and continue to pay it off at a lower rate of interest. The credit card is then not used for anything else.
Is this right for me?
Assuming you are eligible, there are a number of things to consider before taking the plunge into debt consolidation.
The best debt consolidation loans will leave you with lower monthly outgoings which will free up some additional cash flow each month.
Some people make the mistake of trying to consolidate their debts over the longest possible time frame because it gives them more extra cash at the end of each month by doing so. By doing so you will increase the amount of interest you pay over time and you will end up paying more than if you had not consolidated your loan in the first place.
This is particularly common where people consolidate their loans into a home loan.
Refinancing Home Loans: Beware the Traps!
Take the following example which should serve as a warning as to why it is not always wise to consolidate your loans over a longer period.
John has 3 outstanding loans totalling $10,000 all due to be paid back within 5 years.
Total interest payable on $10,000 over 5 years = $11,071
He decides to consolidate these outstanding loans and wrap them up with his home loan which is repayable over 25 years at a lower rate of interest of 7%.
Total interest payable on $10,000 over 25 years $47,254
That is a 426% increase in interest payable.
You see, while Johns outgoings were reduced over the short term, he ends up paying back the principal sum for much much longer than would have done.
Add to this arrangement fees, legal costs and other charges associated with paying off your existing finance and taking out the new loan and it may not make sense to consolidate.
Only consolidate your debt where you intend to pay it off over the same time frame as your existing liabilities.
The Risks of Debt Consolidation
People looking to refinance can often be in a vulnerable situation and unscrupulous lenders are more than willing to target people who need money in a hurry.
They do this by:
Charging them high fees, sometimes more than 20% of the equity in their home
Arranging a refinancing agreement where it is extremely unlikely that the borrower will be able to afford the new repayments
To guard against this always ensure you use a lender who is registered with the ASIC. You can do this by searching the ASIC Connect's Professional Register to check your credit provider has been licensed or you can phone ASIC's Infoline on 1300 300 630.
My advice would be to go and speak with your high street bank first of all. They may not offer you the best deal on a loan but they will not be able to give you unethical advice. Use them to educate yourself on the issue and if you feel that they have the best offer for you, take it.
If not, look elsewhere with the benefit of a little extra knowledge.
What are the rates of interest?
This is one of those, how long is a piece of string questions. It will depend on the length of the loan, your credit history, the amount you are looking to borrow etc.
Banks often provide attractive 3 year fixed rates for loans. Don’t be surprised to be offered rates up to 20% if your credit history is less than ideal though.
What if I am not eligible for a debt consolidation loan?
In the event that lenders are not willing to take you on then you must resort to tried and tested financial common sense in order to reduce your outgoings.
Take the loan with the highest rate of interest, make the largest payments on this one first.
If the interest rates are the same, pay of the smallest one first, you will feel a sense of accomplishment when you do.
Cut up your credit cards. If you cannot afford to repay your loans you cannot afford any more debt!
Cut Back!! Broadband/telephone/mobile use, being more energy conscious (turn off lights, don't run the AC 24/7 etc), use your car less (only for travel to work) etc.