The Mortgage Agency
Debt Consolidation
If you feel like you’re becoming overwhelmed by your mortgage repayments and other financial obligations, a viable way out could be to undertake a debt consolidation strategy.
Consolidating debts means combining multiple debts into one payment, such as credit card debt, car loans, and personal loans so that you only have to manage one monthly repayment instead of multiple loans. This makes your finances more manageable and easy to keep track of.
There is a common misconception that debt consolidation will lead you to pay higher interest rates, making it more expensive over time. But this isn’t necessarily true. In fact, you can often secure a lower interest rate for your repackaged loan compared to paying off each of your loans separately.
But be aware that it will end up being more expensive in the long term if you apply a longer loan term to that debt, so don’t take on more than you can handle.
How Does Debt Consolidation Work?
When you receive a loan for debt consolidation with a new lender, you can use the funds to pay off all of the separate loans you currently possess. You will then have a new consolidated loan that you can pay off as a lump sum each month.
For example, if you had a personal loan worth $5,000, and $1,500 of credit card debt, you could apply for an $8000 consolidation loan (the cost of all of your other loans combined) under a new lender.
If your application is successful, you can use the new money in your bank account to pay off your car loan, personal loan, and credit card debt. Then, you’ll pay a single sum each month toward the consolidated $8000 loan with your new lender.
As you can see, a consolidation loan won’t reduce the amount that you need to pay, but it will make it easier to manage your finances every month. You may also be able to secure a lower interest rate, meaning it could work out cheaper in the long run, provided your loan term doesn’t increase.
Related: What Is Common Debt Reducer?
What Debt Consolidation Loans Are Available?
The overarching concept of debt consolidation is combining multiple personal or business loans into a single lump sum. But beyond that, there are several different variations that cater to different circumstances.
Balance Transfer Credit Cards
One way to consolidate your credit card balances is through a credit card balance transfer. This is the process of moving all of your outstanding debts from one or more personal or business credit cards onto a new card.
Many balance transfer credit cards come with 0% APR for an introductory period, usually between 12 and 18 months. This means you won’t pay any interest if you pay off your existing debt during that period. However, you may need to pay an establishment fee of 3% to 5% of the amount you transfer.
Balance transfer credit cards are useful, provided you can pay off the entire balance before the introductory 0% APR period ends. After that, the rates can quickly rise, and you may end up paying more interest than you initially started with. Therefore, we don’t recommend this approach if you’re consolidating a large amount of debt.
Home Equity Loans
Your home equity is the difference between your home’s value and the amount you currently owe on your mortgage. If you have enough equity (and a good credit score), you can borrow a portion of it for debt consolidation.
When you successfully apply for this loan, you’ll get a lump sum at a fixed/variable interest rate, which you can use to pay off your debt. You’ll then pay back the lump sum in installments.
Home equity loans are often known as a type of ‘secured’ loan because the bank can seize your home if you don’t pay back. Therefore, these loans are only suitable if you are confident you can make regular debt repayments. That said, secured loans are a lower risk to lenders as they make all their money back, so they often provide them at a lower interest rate.
Personal Loans
Personal loans are unsecured loans from private banking institutes or online lenders that can be used to pay off multiple debts at once.
Unlike a home equity loan, the personal loan isn’t secured by any of your assets, meaning you won’t lose your house if you can’t pay. That said, failing to pay will still impact your credit score, and you may face legal repercussions.
An unsecured loan doesn’t give the lender any security regarding the risk of the borrower defaulting on their payments. Therefore, using unsecured personal loans to consolidate your debts can be expensive and may attract higher interest rates.
The main reason why people opt for an unsecured personal loan for debt consolidation is that their assets aren’t at risk of repossession by the bank if things go south. Alternatively, they might simply not have a property or sufficient equity to consolidate these loans.
Debt Management Plan
Lastly, there’s the option of a debt management plan (DMP). This involves working with a debt management company that will negotiate with creditors on your behalf to secure lower interest rates, lower monthly payments, or a combination of the two.
After this, you’ll send a single payment each month to the debt management company rather than paying off your debts individually. The company will then use the money to pay your creditors. The personalised interest rates mean you should, in theory, pay less over time.
Know that these companies will usually only take on unsecured loans (loans not secured by your assets). They also won’t work with student loans. In addition, you may have to pay a small account fee (around $50) upfront, alongside a monthly fee ($30 to $80). You may also need to pay a termination fee if you want to exit the plan early.
DMP is typically reserved for those experiencing financial hardship who are struggling to pay large amounts of unsecured debt. If you’re just looking to consolidate a few debts for simplicity and potentially lower interest rates, a personal debt consolidation loan may be a better option.
Fixed vs Variable Interest Rates
Fixed Interest Rate
A fixed rate loan locks in the interest rate at the time of signing for the full loan term. This means that the interest rate on your personal loan will stay the same regardless of whether the cash rate goes up or down. This works to your benefit when loan rates rise, but can be detrimental if rates drop as you will pay more.
Loans with fixed rates aren’t generally very flexible as they don’t offer extra features. For example, preemptively paying off personal loan amounts might result in early repayment fees and charges.
Variable Interest Rate
A home loan with a variable rate is subject to change as per the cash rate. This can be a good thing if it goes down, but there’s always the risk of the interest rate rising, and you’ll have to pay a larger home loan repayment amount.
Variable interest rate loans typically offer additional features like an offset account or a redraw facility. These are accounts linked to your loan that are similar to a savings account. The funds are offset against the balance of your loan, potentially saving you thousands of dollars in interest.
Is Debt Consolidation A Good Idea?
Debt consolidation is an excellent way to take control of your finances if you have several unpaid debts and are in good credit standing. That said, it might not be the right choice for everyone. Let’s start by taking a look at some of the benefits of consolidating.
- Simplify Your Finances: Debt consolidation will save you a lot of time and energy because you’ll only need to pay off one loan every month rather than several. This is especially important if you have a large number of loans of various sizes and interest rates that you’re struggling to stay on top of.
- Budgeting: A single monthly payment lets you budget around one date in the calendar, such as the first day of each month, rather than needing to make several smaller payments throughout the month.
- Planning: Consolidating debts makes it easier to know exactly when your loan term will end. This takes a lot of the uncertainty out of making repayments, taking some of the weight off your shoulders.
- Lower Interest Rates: You may have the opportunity to secure a lower APR with your consolidated loan. For instance, if you currently owe a cumulative $10000 at 20% APR and you consolidate that debt into a 15% APR loan, you’ll save an estimated $5940 over five years of paying back your loan.
As you can see, whether or not a debt consolidation loan is worthwhile will largely depend on the interest rates you can secure. Securing the best interest rates means ensuring your credit score is favourable. Let’s discuss that topic.
Check Your Credit Score Before Undergoing Debt Consolidation
Your credit rating reflects your liabilities and whether you have honored them well in the past or not. Any missed payments will negatively affect your credit score.
It’s a good idea to check your credit score yourself before you apply for a debt consolidation loan. You might find that you’ve forgotten about missed payments in the past and, therefore, prefer to wait a bit longer before you apply so that you can build a good credit history and increase your borrowing power first.
A bad credit score could lead to a declined debt consolidation loan application, so taking the time to ensure your credit score is good before applying can work in your favour. Additionally, a good credit score could also make it easier for you to secure a low interest rate, as the bank will see you have a track record of paying back loans by their due dates.
Related: Bad Credit Loans: A Comprehensive Guide For Borrowers In Australia
How The Mortgage Agency Can Help
Navigating all of the debt consolidation options, products, and features can be challenging without the right financial assistance. If you’d like some support to understand the options available to you and learn which one is the right fit for your circumstances, The Mortgage Agency is here to help.
As professional mortgage brokers with decades of combined experience helping Australians manage and navigate their loan repayments, we have the expertise to guide you through the process of consolidating your debts.
When you book a free discovery session today, we’ll take the time to understand your financial situation and recommend the best approach based on your individual circumstances. We care about building long-lasting relationships with our clients and will put in the work to offer financial advice that puts your needs first.
Once we’ve agreed on a personalised solution, we’ll work with you to collect any necessary documents. We’ll then connect you with a reliable lender with a valid Australian Credit Licence and favourable comparison rates so you can begin the application process with our support.
If you’d like to learn more about our service, contact our friendly team. We’ll explain everything to you in detail and answer any questions you may have along the way. We’ll help you save money and become debt-free faster.
Frequently Asked Questions
From our experience, debt consolidations usually take around two to four weeks from beginning to end. The majority of that timeframe will be spent waiting for loan approval as the lender checks whether you meet their eligibility criteria and carry out their credit assessment.
That said, this process can be quicker or take longer depending on a few factors, like the method of consolidation you choose and your credit score. Securing a balance transfer credit card with a high credit score will usually be faster (and easier) than getting a personal loan with a low credit score, for instance.
Debt consolidation can negatively impact your credit score in the short term because of the need for a credit inquiry and the requirement to create an additional account to accommodate your debt.
That said, as long as you manage your debt responsibly and make every additional repayment on time, any negative effects will only be temporary. In fact, debt consolidation can be an excellent way to build your credit score higher by regularly making payments on time.
Most debts can be consolidated in some way, shape, or form. Credit card debts, medical loans, home renovation loans, student loans, personal loans and even mortgages can be consolidated when you choose the appropriate package.
Different types of debt are better suited to different variations of consolidation. For instance, credit card debts are often best managed through balance transfer credit cards or personal loans, whereas mortgages benefit from home equity loans.
The outcome depends on the type of loan and the terms of your contract. With an unsecured loan, your credit score will be negatively impacted, and you may be asked to pay back the amount you owe plus interest, meaning you could end up in more debt.
If you have a secured loan, your lender could seize the assets against which your loan is secured. It’s important to budget diligently to make sure you can make repayments in order to protect yourself.
