Money and Life
(Financial Planning Association of Australia)
What’s debt consolidation and do I need it?
Debt consolidation could be a solution, but tread carefully: there are no easy fixes.
Debt consolidation involves taking all your monthly debts – for example, from your credit cards, store cards, mortgage, car and other loans and so on – and rolling them into a single low interest rate loan.
If you are rolling all your debt, including high interest rate credit card debt, into this loan, your required monthly interest repayments should be lower than before. Better still, this could help you get rid of your debt faster as you may be able to make bigger repayments on your loan.
It could also simplify your life. That’s because you will only need to make only one repayment each month, cutting down on the time and paperwork needed to manage several accounts. Plus, you will be paying loan fees on only one loan, and not many. With only one loan to pay, you are also less likely to miss a payment. And, because the interest rate is usually fixed or known, it could be easier to budget and predict your expenses.
If you do your sums on just the pure interest rate charges, you are likely to find that the interest rate on your mortgage is considerably lower than that on your credit cards. That’s because it’s a secured loan; it’s secured by an asset (your home) reducing the lender’s risks.
Plus, your mortgage may be linked to an offset account, which will help you further save money in interest.
What to be aware of when considering debt consolidation
But what often isn’t properly explained is that just rolling your debts into a mortgage can be really expensive. For example, there are a range of charges associated with refinancing your mortgage, including application, legal, conveyancing, transaction and valuation fees.
The costs of exiting your current mortgage could include government charges and a mortgage de-registration fee. And, you may also have to fork out for new loan fees such as title search, establishment and settlement fees.
And, if you do consolidate your debts into your mortgage, which is secured by your home, you face the risk of losing your home if something goes wrong. Plus, your mortgage’s repayment period is also likely to be much longer than that on your credit cards or other loans. That means you could be stretching the repayment of short-term spending over many years, which may actually increase the total amount you end up repaying over the long-term.
Much will depend on how big your debts are and you will have to do your sums carefully.
Other options to consider if debt consolidation isn’t right for you
For smaller debt, a better solution may be a personal loan from your bank or a low interest credit card with an interest free period which can help you get things under control without paying interest.
Also, if considering debt consolidation, be careful who you deal with. The government’s MoneySmart website warns borrowers to avoid some the dodgy brokers and lenders out there who take advantage of people struggling to rein in their spiralling debt. They may do this by charging them high fees or by equity stripping, where they create refinancing arrangements even though they believe the borrowers will struggle to afford the new repayments
Thus, it’s crucial to carefully check out who you borrow from. The possibilities in Australia are wide and could include family members, your bank, smaller lenders and peer-to-peer lenders. Their rates, terms, other charges and quality of service will vary and it’s important to do your homework and shop around.
But remember, consolidating your debt is no panacea. It’s certainly not going to solve your problems if you don’t learn how to budget and save effectively, or if it just allows you to borrow more money, placing you even deeper into debt.
To avoid future problems, it’s important to learn how to better manage your debt. It may also pay to talk to a qualified financial planner who will analyse your situation, help you prioritise your debts, work out the best debt reduction strategy for you personally and help you consolidate your debt, if that’s what you need to do.
A good planner can also help you set financial goals, develop a budget, better manage your cash flow, create a savings plan and generally become smarter with your money.