If you’re struggling to keep up with multiple monthly loan repayments, debt consolidation (or refinancing) could be a good solution.
Read on as we go into all the details of debt consolidation—from the different types of consolidation loans available to the benefits and downsides of refinancing.
What Is Debt Consolidation?
Debt consolidation is a type of refinancing deal where you take out another loan to pay off multiple existing debts. If you have several high-interest debts, you can roll them into one loan with a potentially lower interest rate. Bundling several loans together also allows you to save money on fees and interest and possibly pay your debt off faster.
Debt consolidation may sound like the ideal solution, especially for the 37% of Aussies households who struggle with debt, but it may not be the best option for everyone.
Before you opt for refinancing, you need to make sure that the interest rate and fees on the new loan are lower than what you are currently paying. What’s more, getting more credit could tempt you to overspend and push you further into debt, so you will need a lot of financial discipline to make debt consolidation work for you.
How does debt consolidation work?
Let’s say you have a credit card debt of $4,000 and a personal loan of $8,000. Both of these debts come with separate interest rates, repayment amounts, loan terms and administration fees. You could consolidate both these payments into one easy-to-manage loan with a single interest rate.
Depending on the rate you get, you could end up paying $320 a month, saving $74 each month.
Why should you consolidate debt?
As mentioned above, consolidating your debt comes with certain benefits.
Finances are easier to manage
When you roll your loans into one you will only deal with one lender and have only one repayment to make each month. This not only simplifies your finance management but also lowers the risk of missing payments and paying late fees.
Save money
Instead of paying interest and fees on several loans or credit cards, you will be making one lower monthly payment which should save you hundreds or even thousands over the life of the loan.
Can help you pay your debt off faster
Consolidating your debt into one loan will provide you with a clearer timeline of when you will be debt-free which might just motivate you to clear off your debt faster. That said, make sure your new loan doesn’t come with huge early repayment fees. If this is the case, you need to pay off the loan by the set deadline and no sooner than that.
Types of Debt Consolidation
There are several ways to consolidate debt in Australia—which one is best for you depends on the type of debt you have, your financial circumstances and your eligibility.
Personal Loan
Personal loans are the most common form of debt consolidation—you basically take out a new loan with a lower interest rate than your current loans and use it to pay off your existing financial obligations.
However, personal loans tend to come with higher interest rates than mortgage refinancing. For instance, in 2020, the average fixed interest rate on personal loans in Australia was 12.46%, while the mortgage rate was around 3.63% around the same time.
Balance transfer credit card
With this method, you are transferring your personal loan and/or credit card debt to a new card. Typically, you will not pay any interest over the first month or months, after which the standard rate will apply.
This can be a great option to refinance your credit card debt—you simply move your balances to a new card and repay as much as you can during the promotional period of 0% interest. It’s a bit trickier to refinance personal loan debt with a balance transfer credit card as most providers will not allow you to transfer more than 80% of your approved credit limit. So, if you have $10,000 left on your personal loan, you can move $8,000 to your new credit card, while the remaining $2,000 will be left on your existing balance. In other words, you will still have two loans to pay off which more or less defies the purpose of debt consolidation.
Did you know that more than half of Australians dip into their savings to pay off credit card debt?
Refinancing your home loan
A final option is to refinance your home loan. This method basically allows you to tap into the equity you have in your home and use it to repay your other high-interest debts.
Refinancing your mortgage is more affordable than a personal loan or credit card since home loans have much lower interest rates. What’s more, if you opt to release equity as a home loan line of credit you will only repay what you spend instead of paying off the entire loan. Alternatively, you could apply for a home loan increase—you will bundle all your debts in your home loan and instead of making several repayments, you will have one bigger monthly payment.
However, you are using your home as security, so if you can no longer make repayments, you risk losing your house.
Debt Consolidation Refinancing Process
If you are set on consolidating your debt, these are the steps to follow.
Related reading: How to release equity to buy a second property?
1. Calculate how much you owe
Make a list of all the loans you are paying off. You can go through your monthly online account or check your credit history to ensure that you list all your debt.
Tip: Don’t just calculate the principal owed. Instead, determine exactly how much is remaining on your loan (including interest and administrative fees). You can use an online calculator to help you out.
2. Find a lender
You should first check with your current loan provider to see if they can offer you a better refinancing deal. If not, you need to shop around and find a lender that
- Is willing to offer a lower interest rate than what you are currently paying
- Has lower ongoing fees than your existing loans
- Can offer the full amount you need to cover your debt
When comparing lenders, you should also check their eligibility criteria and see whether you qualify. Lenders have their own approval standards, although most look at your overall affordability, i.e. whether or not you are able to repay your loan. If your credit score is not good or great or you do not have a steady source of income, you may not be eligible for refinancing.
Note: If you have a mortgage offset account or a redraw facility, you need to find out what happens to the money in the accounts before you refinance.
3. Check how much it will cost you to pay off your loans early
Look over the loan agreements with your current lenders or contact them directly to find out how much you will need to pay to settle the loans early. Also known as early penalty fees, this could offset some of the savings you make when you consolidate your debt.
4. Apply for refinancing
If you are able to find a loan that will cover all your existing debt and has a lower interest rate than what you are paying at the moment, apply for refinancing.
Can’t Pay Off Your Debt: What Are Your Other Options?
When debt consolidation is not an option for you, you are left with a few insolvency alternatives, including
- Temporary debt protection (TDP): Offers 21 days of protection from unsecured creditors;
- Debt agreements: Enables you to make flexible smaller payments on your debt when you can afford them
- Personal insolvency agreements: Allows you to pay off a fixed sum instead of making payments when you can afford to
- Bankruptcy: After 3 years and one day, you will be released from your debts (most of them), but bankruptcy will seriously impact your credit score and even your ability to travel abroad or get a certain type of job. It should only be considered as a last resort.
Debt Consolidation: Final Tips
If you do opt for debt consolidation, make sure that you avoid the following pitfalls.
Note: Learn more about your rights when dealing with debt collectors and your insolvency options before you take any definitive steps.
Avoid companies with unrealistic promises
You may be approached by organisations that promise to clear your debt no matter the amount or your credit history. Usually, if the offer sounds too good to be true, it probably is a scam.
When comparing refinancing lenders always go for companies that
- Are licenced (check ASIC’s official site)
- Have open and transparent pricing
- Do not ask you to sign any blank documents that do not include the interest rate or loan amount
Ensure you will be paying less
Debt consolidation could end up costing you more in the long run, especially if you get a higher interest rate than what you are paying now. Therefore, you must compare your current interest rates and repayment amounts with the new loan to make sure that it will cost you less over time.
Make sure that you’ve exhausted all other options
Talk to your loan provider or creditor before you apply for refinancing.
If you’ve lost your job or are experiencing financial difficulties, you could qualify for a hardship variation. In this case, your lender might pause your payments or extend your loan term, giving you time to get back on your feet. Those with credit card debt can try and negotiate payment terms with their credit providers. You could also get free legal advice if you need more help when deciding whether or not refinancing is the way to go.
Bottom Line: Should You Consolidate Debt?
If you have a hard time keeping track of multiple debts or you need some leeway with payments you can combine several balances into one longer loan. Before you do, though, check and double-check that you will in fact be paying less in the long run. This means calculating all the expenses over the life of both loans to see how much you will be able to save.
However, if you are struggling to make monthly payments, debt consolidation may not be the best idea. Those who cannot afford several smaller payments are unlikely to be able to pay off one larger debt, which might push them into more financial trouble. If you are experiencing financial hardship, talk to your mortgage broker or financial advisor, or better yet contact your lender or creditor directly—they might be able to help you explore other options.
1. Is debt consolidation the same as refinance?
Debt consolidation and refinancing are very similar. In fact, the debt consolidation vs refinancing distinction boils down to this: a debt consolidation loan is an additional loan you take to pay off your existing debt, whereas refinancing is when you extend or increase your loan (usually your mortgage) and use the extra money to cover existing financial obligations.
So is it better to refinance or consolidate?
It depends on your needs and the type of debt you have. Refinancing a home loan is more affordable, but riskier since you use your house as security. On the other hand, consolidating your debt with a personal loan comes with higher interest rates, but it is less risky.
2. Does consolidating credit affect your credit score?
Debt consolidation or refinancing may not have an instant impact on your credit rating, but if you manage to make timely payments you could improve your credit score over time.
