A debt consolidation loan essentially combines all of your various debts (such as credit card debt and personal loan debt) into one loan with one easy repayment. This makes managing your debt easier, but before consolidating your debt, there are a few things you should consider first.
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What is a Debt Consolidation Loan?
A debt consolidation loan is a type of personal loan that allows you to pay off many different types of debt (such as credit card debt, personal loan debt, etc.) at an interest rate.
While this method can make it easier to manage multiple debts, it can also backfire if you roll over your debt with a longer loan term, thereby ending up paying more interest than you would have had you just paid off your debt in the /the original credit period/s. This is more common when you combine your debt into a home loan, but it can also happen with personal loans if the new remortgage loan term is longer than the original loan term.
Benefits of consolidating debt with a personal loan
Consolidating all of your debt into a single loan makes managing your debt easier since you only have one monthly payment to make.
You may get a lower interest rate.
If you consolidate all of your debt into one loan, you may have fewer account maintenance fees to worry about.
Disadvantages of consolidating debt with a personal loan
If you don’t make repayments on time, you could end up increasing the amount of your debt through late payment fees and accruing further interest.
You may have to pay disruption costs for terminating existing loans.
If you don’t keep up with your repayments, you could damage your credit score.
Do’s and Don’ts of Debt Consolidation Loans
- TO DO Shop around and compare debt consolidation loans to find one that works for you with a competitive interest rate and terms. When comparing loans, don’t forget to pay attention to the comparison rate, as this often better reflects the cost of the loan because it takes the fees into account.
- TO DO Look for a debt consolidation loan with flexible features, such as: B. the ability to make additional repayments without being financially disadvantaged and a flexible repayment frequency.
- TO DO Remember to consider all costs before consolidating your debt into a single loan. There are setup fees, early repayment fees, loan application fees, potential loan disruption costs, and other fees. You may even find that consolidating your debt doesn’t make financial sense as it could end up costing you more than continuing to pay off your current loans.
- TO DO Set up automatic payments so you never forget your monthly or fortnightly repayment. You can easily set up automatic transfers to your lender through your online banking app. You can schedule your automatic payments to coincide with payday, so your debt is being paid off in the background and you don’t even have to think about it.
- NOT roll your debt into your mortgage (at least think VERY carefully before doing so). Mortgage repayments have very long repayment terms (25-30 years) and if you stretch your short-term debt to such a long repayment term, you could be paying thousands more in interest and fees.
- NOT move to a longer loan term without considering the financial implications. While this can reduce your monthly repayments, you could pay a lot more in interest and fees over the life of the loan than if you just paid off the debt within the original time frame.
- NOT take on more debt. If you already have credit card or personal loan debt, don’t apply for more credit cards or payday loans to get by. Borrowing even more to pay off your existing debt may present itself as a “stop-gap solution,” but it can send you into a debt spiral. If you’re really struggling to get your debt under control, there are other options, which we’ll discuss later.
Other ways to consolidate your debt
In addition to consolidating your debt through a personal loan, there are two other common methods of debt consolidation:
Credit card balance transfer
For those of you who have credit card debt on multiple cards, you can consolidate all of that debt onto a single card with a balance transfer.
This method shifts your credit card debt to a card with a lower interest rate or even a 0% interest rate for a limited period of time (promotional or honeymoon period), which can last anywhere from three to 26 months. In theory, you should aim to pay off all your debts without paying any further interest on that honeymoon.
However, if you fail to pay off all of your debt before this deadline, any unpaid debt will be charged at a repayment rate that is typically well above most credit card rates. For example, most credit card interest rates are around the 17% mark, while the average payback rate is 20% and in some cases can be as high as 24%. An ASIC review found that 30% of balance transfer users increased their debt by 10% or more because of this – not really the ideal result when the whole point of a balance transfer is to get rid of your debt and not go further into it .
Consolidate debt into your home loan
The other popular method of debt consolidation is to roll all of your debt into your mortgage. In order to pack all of their existing debt into their mortgage, many homeowners refinance their home loan into a larger loan or apply for an increase in their existing home loan. In this way, all of their debts will gradually be paid off through their regular mortgage payments.
One benefit of this strategy is that most home loans today have very low interest rates of between 1-3% compared to personal loan and credit card interest rates which hover around the 17% mark. While it may seem like a no-brainer to consolidate your credit card and personal loan debt into your low-rate home loan, doing so can backfire since mortgages have very long repayment terms, typically between 25 and 30 years. Extending short-term credit card and personal loan debt to such a long loan term means you may end up paying thousands more in interest and fees over the life of the loan.
If none of these methods appeal to you and you would rather approach your debt without consolidating, there are several other debt relief strategies such as the “snowball” or “avalanche” strategies.
The two cents from Savings.com.au
Debt consolidation has its merits as it can make managing your debt much easier as you only have to deal with one loan repayment instead of juggling multiple loan repayments across different debts. If debt consolidation isn’t right for you, there are other debt reduction strategies you can try, such as: B. the snowball method or the avalanche method, which we linked above.
If you see that none of these options work, don’t be afraid to reach out to your current lender and ask what financial hardship options they offer. DO NOT take on more debt to try and manage your current debt. Payday loans and credit cards can seem like a “stop-gap solution,” but taking on more debt to pay off your current debt will only send you into a debt spiral — it’s just a recipe for disaster.
Once you’ve worked your way out of debt, it’s extremely important to sit down and analyze what got you into that debt in the first place so you don’t end up in the same situation again. Create a budget and consider cutting back on your credit cards so you’re not tempted to use your card to pay for future expenses. If you’re the type of person who has trouble controlling your impulse spending, trimming your cards is probably a good idea.