What are debt consolidation loans?
A debt consolidation loan is generally just a personal loan. But instead of taking out money to cover a holiday, car or other purchase, you're using the money to pay off outstanding debts.
The goal with debt consolidation is to combine multiple debts, each with different interest rates and fees, into a single personal loan. Done correctly, you should save money by having a single, more manageable repayment. Not only does this mean more money in your pocket, but also makes budgeting much easier.
You need to make sure the new loan works out to be more cost-effective than keeping your existing debts separate.
What debts can I consolidate with a personal loan?
How to consolidate your debts in 5 simple steps
- Take stock of your existing debts. Work out how much you're paying each month in fees and repayments. Count up your total remaining debt amounts so you can work out how much to borrow.
- Compare personal loans and find a suitable loan. Look for a new loan with a lower interest rate and minimal fees.
- Crunch your costs. Before applying for a new loan, use a loan calculator and make sure the new repayments will be lower than what you're currently paying.
- Apply for the new personal loan. During the application make sure you select 'debt consolidation' as the purpose of the loan. This means the lender's assessment team knows that you will be paying off outstanding debts with the loan (these debts will show up in your credit report).
- Once approved, pay off your outstanding debts immediately. Make repayments on your new loan until it's paid off.
Example: consolidating 3 debts into one personal loan
You have 3 debts you wish to consolidate. For the sake of simplicity we're assuming each of these debts has a 3-year term.
|Debt type||Remaining debt||Interest rate||Monthly fees||Monthly repayment (inc. fees)|
Over 3 years you would end up paying:
- $16,500 in remaining debt
- $3,764 in interest + fees
- For a total of: $20,264
Now, if you took out a single $16,500 personal loan over 3 years with a $10 monthly fee and an interest rate of 10% you'd have repayments of $543 a month. This means you would end up paying:
- $16,5000 in remaining debt
- $3,027 in interest + fees
- For a total of: $19,527
This works out to be $30 a month cheaper and would save you $737 overall.
Pros and cons of debt consolidation
- Save money. By rolling all your debts into one account, you'll be paying one fee and one interest rate. This will likely reduce how much you're paying for fees and interest.
- Simplify your debts. You will have one monthly repayment to make, one lender to deal with, one set of fees to track and one rate of interest to remember.
- Could improve your credit score While taking out another loan may temporarily hurt your credit score, by consolidating your debt and then paying off the new loan you could see your credit score improved overall.
- Confusing jargon. Watch out for certain "debt consolidation solutions" that are actually a Part 9 Debt Agreement. This is basically a form of bankruptcy and will have long term repercussions on your credit score.
- High rates for bad credit borrowers. If you have a poor credit score, you're likely to be charged a higher interest rate.
- Loan exit fees. Depending on how your existing loans are structured, you could have to pay exit fees if you switch loans as part of your debt consolidation
Is a debt consolidation loan the right option for me?
Whether or not a debt consolidation loan is the best option for you will depend entirely on your personal situation, and if you are really struggling you should consider calling the free National Debt Helpline for advice on 1800 007 007.
Generally speaking though, you should consider a debt consolidation loan if:
- Your credit score has improved since you took out your existing debts
- You have multiple debts from different lenders and are struggling with the various repayments
- The lower interest rate on your new loan is enough to cover potential early repayment or break fees from your old loans
Another thing to consider is that, since this is a new loan, your loan term will be reset. This could be a good or a bad thing depending on your goals.
- If your goal is to reduce your monthly repayments, this new and longer loan term will ease the strain on your day-to-day budget.
- If your goal is to pay off your debt as soon as possible, the longer loan term could end up costing you more in the long run. However, if your new loan allows free extra repayments then you can use any extra cash to pay your loan off much sooner.
Does debt consolidation hurt my credit score?
In Australia, debt consolidation loans won't necessarily harm your credit score, but as with all credit this depends on a few things.
Any loan can damage your score if you apply for too many different loans at once or miss repayments. But meeting every payment on time and fully paying off your debt can improve your score.
Multiple debts, especially high interest debts, can also affect your score. So consolidating these debts and successfully meeting the payments of your new loan can be an overall benefit to your credit score.
You should also try to take steps to improve your credit score before applying for the loan. And don't apply for multiple loans at once.
Alternatives to debt consolidation
Talk to your lenders about hardship arrangements
If you're really struggling with debts, getting a new loan might only make matters worse. Borrowers in distress should consider talking to their current lenders before they start missing repayments.
Lenders and credit providers offer hardship assistance support for customers. This includes financial counselling, temporary repayment pauses or restructuring of your debts.
Talk to a financial counsellor
If you're struggling with debt and need help you can speak to a counsellor from the National Debt Helpline for free on 1800 007 007.
Refinance your existing debts
Your current lenders and card providers may have similar products with lower rates on offer. Refinancing a personal loan debt could save you money and be a suitable alternative to consolidating your debts.
Balance transfer credit cards
If you have multiple credit card debts you could consolidate them into a single card with a balance transfer credit card. These cards offer a 0% interest period which can help you get your debts under control. This period typically lasts between 12 and 34 months.
But if you don't repay your debt during the 0% interest period you'll be charged a high interest rate.
There are some card providers that even let you transfer personal loan debt to a balance transfer card. But you'll need a good credit score.
Home loan debt consolidation
If you have a home loan and you've been making regular repayments your lender may let you refinance the loan to consolidate other debts.
This might seem like an attractive prospect because your home loan rate will be lower than the rates on other debts. But home loans last for decades. So while it might only add a little to your repayments each month, you could be stretching your debts out for years or decades.
This will cost you a lot more in interest.
Can I get a debt consolidation loan with bad credit?
If you're struggling to manage multiple debts then you may already have a bad credit score. But borrowers with bad credit can still get debt consolidation loans.
Here are some tips:
- Improve your credit score before applying. A small improvement to your credit score could make all the difference.
- Get a risk-based personal loan. Many lenders offer risk-based pricing, which just means lower rates for good credit borrowers and higher rates for borrowers with lower scores.
- Check eligibility requirements before applying. A rejected application harms your credit score, making it even harder to get your next loan approved. Lessen your chance of rejection by checking a lender's eligibility requirements before you apply.
- Look at specialist bad credit lenders. There are lenders that specialise in lending to borrowers with poor credit histories.
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