Debt consolidation loans

How does a debt consolidation loan work?

A debt consolidation loan is a personal loan taken out with the purpose of using the money to pay off your other debts. You can do this to save money as, depending on your other debts, the interest rate of your new loan may be less than what you are currently being charged. This can be particularly true if you are paying fees for your other debts.

With just one debt payment to make, it will be easier for you to manage, track and make your repayments. It can give you greater control over your finances and a clearer timeline of when you will be debt-free.

While a debt consolidation loan may sound like a perfect solution, it can only help you if it costs less than all your other loans combined. Before taking one out, make sure to calculate if you will be paying less than you currently are.

In your calculations, you should factor in not only the overall cost of the loan but also the cost associated with exiting other loan contracts.

When to consider a personal loan for debt consolidation

How do I know if a debt consolidation loan is right for me?

1. Work out how much you need to borrow to cover your debts.

   • How to work out how much you need to borrow

     • First, make a list of all your debts. You can do this by checking your credit report for free here. This will include details of the credit products you hold as well as your credit inquiries, defaults and repayment history. Alternatively, you could also sign into your online accounts to retrieve your current account balance.
     • Write down how much you owe, matching the debt with the total amount due. If you have credit card debt, write down the outstanding amount. The same goes for your other debts.
     • Check with the service provider if there is an early exit fee. Some personal loans, for example, come with break fees.
     • Add the amount owed plus any exit fees to calculate how much you owe in total.
     • Calculate how much interest you will pay with your current debts. Compare this to the total interest you'll pay with the new loan.
     • Before you take out a debt consolidation loan, you should look into whether you can manage without the loan.
2. Research and compare personal loan products to find one that meets your needs. Personal loans are usually suited for debt amounts from $8,000 up to $50,000.
3. Compare your total debt with the debt you'll be incurring with the new personal loan. Does it cost more to take out a new personal loan? If yes, do not proceed with taking out the loan. Talk to a financial adviser instead to work out strategies on how to manage your existing debt.
4. If it's cheaper for you to take out a new personal loan and consolidate your debt, then you can apply for the personal loan. Make sure you check the eligibility criteria to see if you meet them.
5. Use the funds to pay off your other debts, along with any fees or charges.
6. Continue to make repayments on your personal loan until it has been repaid. There are other methods you can use to consolidate debt. This can include using a credit card. You can read our comprehensive guide to debt consolidation here.

Alternatives to personal loans for debt consolidation

Debt consolidation loans are not the only type of credit if you're struggling with debt. Based on your needs and the type of debt you have, you could also look into the following options. However, you should carefully consider the consequences of any of these options.

• Balance transfer credit cards. If you have credit card debt across multiple accounts, you could consolidate it into a single card with a balance transfer. You will pay 0% interest for a specific period. Some card providers offer up to 24 months interest-free. However, if you fail to pay your debt during the interest-free period, you may end up paying higher interest after this period. Certain credit card providers also let you balance transfer personal loan debt to a credit card. You will need good credit to be approved for this. Keep in mind that every credit enquiry recorded on your credit file will affect your score.

• Part 9 Debt Agreements. If you're having trouble paying your debt, you could enter into a debt agreement with a third-party organisation and your creditors. The agreement essentially freezes the interest you're paying and gives you a certain repayment period to pay back what you owe. Some creditors agree to accept less than the full balance for repaying your debt. However, this method shouldn't be entered into lightly. It is considered a form of bankruptcy and has long-term repercussions. It will be listed on your credit report for 5 years and can result in you having difficulty accessing credit in the future.

• Credit counselling. You can enlist the services of a reputable credit counselling organisation to formulate a Debt Management Plan (DMP). Once you enrol in a DMP, the creditors will often reduce your interest rates. Afterwards, you will need to make 1 monthly payment to the counselling organisation. This organisation will handle the repayment to your creditors. This is an option if you can repay your debt within 5 years, but it isn't a decision that should be taken lightly. This should only be entered into if you're having difficulty repaying your debts on your own. There are also fees to consider, and depending on the solution offered, your credit score could take a hit.

Can I get a debt consolidation loan with bad credit?

There are a few ways you can consolidate your debt if you have bad credit:

• Apply for an unsecured personal loan with a specialist lender. Some lenders offer large, unsecured personal loans for people with bad credit. Interest rates are higher than with standard personal loans, but you may still be able to reduce what you're currently paying.
• Consider a Part 9 Debt Agreement. A debt agreement is a form of bankruptcy. It is an option for people with large debts they are unable to repay. The financier will negotiate with lenders on your behalf, and your debts won't accrue more interest. However, this agreement will be listed on your credit file for 5 years from the date you enter into it, which can have long-term consequences for your credit score.

Frequently asked questions about debt consolidation loans

• I'm on Centrelink. Can I still apply for a debt consolidation loan?

  Some lenders class Centrelink as income you can use to service your loan. It's important to find out if your lender accepts Centrelink recipients. If you're on Newstart or Youth Allowance, you may need to speak to your creditors and work out a repayment plan.

• Which banks offer debt consolidation loans?

  Most major banks offer debt consolidation loans. There are also alternative lenders, like online banks and peer-to-peer lenders. Credit unions may offer debt consolidation loans too. You should shop around to find one that works best for you.

• I have some equity in my home. Should I refinance and consolidate debts that way?

  It may be worth considering if you have a large amount of debt to consolidate or if you believe it is the most cost-effective option. You can read our guide to refinancing your home to consolidate debt for more information.

• How can I improve my credit score?

  You can read our guide on improving your credit score here. The good news is that your score gets updated every month. This means that the steps you take to improve it now will pay off sooner rather than later.

• Can I consolidate more than one credit card?

  Yes, you can roll all your credit cards into a new consolidated loan. If you have one card with a $6,400 limit at 19.99% p.a., another with a $1,000 limit at 13.49% p.a. and an "interest-free" store card, you can consolidate them into a new loan.

• Is it difficult to qualify for a debt consolidation loan?

  The eligibility criteria vary between lenders. You may find it easier to qualify with some lenders and for some loans than others. It will also depend on your credit history. A secured loan, for instance, is less risky for lenders as there is security attached. If your credit history isn't great, you may have a better chance of getting a secured loan than an unsecured loan.

• How long does it take to get approved for a debt consolidation loan?

  This will depend entirely on the lender. Some lenders offer quick applications and quick approvals. They may respond within minutes or hours of submitting your application.

• What's the difference between debt consolidation and a debt agreement?

  A debt consolidation loan is a standard personal loan product that allows you to consolidate your current debts into a single debt. A debt agreement is usually taken out by people with large debts and bad credit histories. It is a form of bankruptcy. Make sure you look into the terms of the loan and the effect it will have on your credit file.