Managing multiple debts can be stressful and confusing. Debt consolidation is one strategy that may help simplify your finances, but it's not right for everyone. According to ASIC's MoneySmart, it's important to carefully weigh the costs and risks before consolidating your debts.
What Is Debt Consolidation?
Debt consolidation means combining multiple debts into a single loan. Instead of making several repayments to different lenders each month, you make just one payment to one lender. The goal is usually to simplify your finances and potentially reduce your overall interest costs.
Common Debts to Consolidate
Debts That May Not Be Eligible
Some debts typically cannot be included in a consolidation loan, including:
- - Tax debts (ATO)
- - HECS/HELP student loans
- - Child support payments
- - Court fines
- - Centrelink debts
How Debt Consolidation Works
The process involves taking out a new loan to pay off your existing debts. Here's how it typically works:
Calculate Your Total Debt
Add up all the debts you want to consolidate, including any outstanding fees or break costs. This tells you how much you need to borrow.
Apply for a Consolidation Loan
Apply for a personal loan or refinanced loan for the total amount. The lender will assess your income, expenses, and credit history to determine if you qualify and at what interest rate.
Pay Off Existing Debts
Once approved, the funds are used to pay off your existing debts. Some lenders will pay your creditors directly; others will deposit the funds into your account for you to pay off the debts yourself.
Make One Monthly Payment
You now have just one loan with one regular repayment. This makes budgeting simpler and can help you stay on track with payments.
Types of Consolidation Loans
Unsecured Personal Loan
No asset required as security. Typically higher interest rates but your assets aren't at risk if you default.
Secured Personal Loan
Uses an asset (like your car) as security. Lower rates but the asset can be repossessed if you can't repay.
Home Equity Loan / Refinancing
Uses your home as security. Lowest rates but carries the highest risk - you could lose your home if you default.
Advantages of Debt Consolidation
One Simple Payment
Instead of juggling multiple due dates and payment amounts, you have just one payment to remember each month. This reduces the risk of missed payments and makes budgeting much simpler.
Potentially Lower Interest Rate
If you're paying high interest on credit cards (often 15-22%), a personal loan consolidation at a lower rate (7-15%) could save you money on interest. However, this depends on the rate you qualify for and total costs.
Easier Debt Management
With one loan and a fixed repayment schedule, it's easier to track your progress. You'll know exactly when your debt will be paid off, which can be motivating and less stressful than managing multiple debts.
Potential Credit Score Improvement
Making consistent, on-time repayments on your consolidation loan can help improve your credit score over time. Closing paid-off credit cards (rather than keeping them open and running up new debt) also demonstrates responsible credit behaviour.
Disadvantages and Risks
MoneySmart Warning
ASIC's MoneySmart warns that debt consolidation may cost you more if the interest rate is higher, the fees are higher, or if you take longer to pay off the loan. Always calculate the total cost before committing.
Could Cost More Over a Longer Term
Even with a lower interest rate, extending your loan term means you could pay more in total interest. A $20,000 debt at 8% over 7 years costs $6,186 in interest, compared to $3,442 over 4 years at the same rate.
Risk of Secured Loans
If you consolidate using a secured loan (against your home or car), you risk losing that asset if you can't make repayments. MoneySmart cautions that you should "think carefully before putting your home or car on the line" for unsecured debts like credit cards.
Doesn't Fix Spending Habits
Consolidation only addresses the symptom (multiple debts), not the cause (how you got into debt). Without changing spending habits, you could end up in more debt - especially if you keep using paid-off credit cards.
Could Get Deeper Into Debt
MoneySmart warns that you "could get deeper into debt if you keep using credit or get more credit." Once credit cards are paid off, the temptation to use them again can lead to even more debt on top of your consolidation loan.
Fees and Break Costs
You may face establishment fees on the new loan, plus break costs on existing loans (especially fixed-rate loans). These can add significantly to your total costs and should be factored into your decision.
When Debt Consolidation Makes Sense
Consolidation may be a good option if:
When Consolidation Doesn't Make Sense
Consolidation may not be the right choice if:
Before Consolidating, Calculate the Total Cost
Compare the total amount you'll pay under your current debts versus the consolidation loan. Include:
- Total interest over the full loan term
- Establishment/application fees
- Ongoing monthly/annual fees
- Break costs on existing loans being paid out
How to Apply for Debt Consolidation
List All Your Debts
Gather statements for all debts you want to consolidate. Note the outstanding balance, interest rate, minimum repayment, and any fees for early payout.
Compare Your Options
Shop around with different lenders to find the best rate and terms. Compare the comparison rate (which includes fees), not just the advertised interest rate. A broker can help compare multiple lenders with one application.
Check the Lender's Credentials
MoneySmart recommends checking that any lender or broker is licensed. You can verify their credentials on ASIC's register of credit licensees.
Submit Your Application
Provide the required documents including ID, proof of income, bank statements, and details of your existing debts. The lender will assess your application and advise if you're approved.
Close Paid-Off Accounts
Once your old debts are paid off, consider closing those accounts - especially credit cards. This removes the temptation to run up new debt and shows lenders you're serious about managing your finances.
Struggling with Debt?
If you're having trouble making repayments or feeling overwhelmed by debt, free help is available. Financial counsellors can help you understand your options, negotiate with creditors, and create a plan to get back on track.
National Debt Helpline
1800 007 007
Free, confidential financial counselling. Monday to Friday.
Financial counsellors are independent and don't sell products. They can help with budgeting, dealing with creditors, and understanding your legal rights.
Official Resources
Ready to Explore Your Options?
If debt consolidation sounds right for you, we can help you compare options from multiple lenders. Check what you might qualify for with no impact to your credit score.