What is debt consolidation?
Debt consolidation can help reduce the stress of multiple debts and different interest rates. Paying off more than one debt at a time is not uncommon. But if you’re struggling to balance your debt repayments, debt consolidation may well be worth considering.
Debt consolidation is bringing all your existing debts together into one new debt, which can help you manage your repayments and give you a clearer picture of your financial future. You typically do this by taking out a new personal loan to repay your other existing debts, and then paying this new loan back over a set term.
If you have a home loan you may also have equity in your property that can be used to consolidate debt. However, it’s important to note that debt consolidation can come with some downsides. It can turn a short-term debt, like a personal loan, into a long term debt (your mortgage), and that means paying interest on the balance for a much longer period, which could cost you more in the long run. For debt consolidation to be truly cost effective, you need to commit to making additional repayments to pay off the enlarged loan as quickly as possible.
How does debt consolidation work?
If you have three different credit cards with debts of, for example, $2,000, $5,000 and $6,500, you’re likely to also have three different interest rates and to be making three different repayments at different times each month.
This can feel very overwhelming and complicate managing your cash flow. The interest rates may be different on each card. If the highest rate is on the card with the $6,500 debt, you could be paying plenty each month just to cover the interest, let alone paying down the debt itself.
One option you have is to consolidate your debts is to take out a single personal loan to pay off each credit card and any outstanding interest. With a personal loan you’ll have just one repayment to make every week, fortnight, or month over a set term – you can usually choose your own frequency of repayments.
And if the interest rate on the personal loan is lower than your credit card rates – and they often can be – this can help you get ahead in reducing your overall debt.
The Pros of Debt Consolidation –
- A potentially better (lower) interest rate
- Lowering your monthly payments. Stretching the term on your personal loan means that you could be spending less towards paying off your debt on a monthly basis, although you will end up paying more overall.
- A means of providing a clear timeline outlining when you’ll be debt-free
- Paying once, instead of multiple times a month. Taking out a personal loan to pay down your credit cards as well as any interest you owe means you’ll only have one repayment to make every week, fortnight or month over a fixed amount of time. Managing your debt thus becomes easier.
The Cons of Debt Consolidation –
As with every loan you undertake, there are certain drawbacks. Here are some of the downsides of using a personal loan for debt consolidation:
- If you are using your home loan for debt consolidation don’t take a 30 year loan term. This will cost you more interest if you are repaying the debt over 30 years.
- The potential to accumulate more debt. Consolidating your debt means that you’ll free up credit. But if you’re not careful, you might end up spending more and as a result accumulating even more debt than you started with.
- Spending more overall. As mentioned above, a personal loan with a longer term can help you reduce your monthly repayments, However, a longer loan term means you’ll pay more interest and spend more overall.
- Damaging your credit score. If you don’t keep up with the monthly repayments on your personal loan, you could end up hurting your credit score or worse, be in a serious financial hardship.
My biggest piece of advice if you consolidate debt is to cancel the debt you consolidate. Cut up credit cards, close any facility that is consolidated and make extra repayments to repay the debt as fast as you can.
If you would like to make a time to speak and see if debt consolidation is right for you please make an appointment today.
Donna.
