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What is a debt consolidation loan?
Most Australians have at least one form of debt, which could be a credit card or a home loan. Sometimes, managing these repayments can become more stressful than it needs to be, and it can be useful to ask yourself if you need to consolidate debt.
In Australia, a debt consolidation loan is a financial product you can use to integrate all your debts into one loan. If you’re smart about choosing a consolidation loan, you may also pay less interest over the longer term.
How do I consolidate debts?
Debt consolidation, also known as ‘refinancing’, is very much like rolling all your debts under one single umbrella. This can be convenient when you have, for example, credit card debt, a car loan, and a mortgage. As you might have different repayment plans for each, a personal consolidation loan can help to simplify things. With one regular loan repayment each period rather than multiple separate repayment schedules, your finances can become more manageable.
Consolidation loans can reduce interest payments
Besides simplifying your repayment plans, a debt consolidation loan with a lower interest rate can reduce your total interest payments. As an example, let’s say you are currently paying 20% interest on your credit card debts, 8% interest on your car loan, and 5% interest on your mortgage. Here, a debt consolidation loan with an 8% interest rate may make it easier for you to meet your monthly repayments.
What to consider before you consolidate debt?
Like most personal loans, choosing the best means comparing more than just interest rates. Fees, charges, and potential restrictions can make a real difference in terms of what you will be paying overall. Likewise, you will want to think about repayment periods and redraw facilities to get the whole picture.
Most importantly, you should think about whether you’ll be able to afford the repayments on your new loan after you’ve consolidated your debt. For this reason, it’s crucial to consider a few key things while you compare deals before settling on a product.
- Changing your mortgage – switching up your home loan could be an alternative way to reduce the interest payments and fees you are currently paying. If you can find a better home loan, this could be another option to help you consolidate debt.
- Discuss your options with your current loan provider – in Australia, some lenders might allow you to rearrange your repayment schedule. A longer loan term could reduce some of the pressure of repaying your loan.
- Credit card balance transfers may help you consolidate debts – Transferring some of the debt on one card over to another can sometimes help you cut down on interest payments. Do think this through properly before you transfer your balance, as you may end up finding yourself under greater financial stress.
- Consider selling your property – This might not sound ideal, but can be a clever move if you are looking to eliminate home loan repayments permanently. In Australia at least, you’ll also likely obtain a higher price for your home than your lender would in a mortgage sale.
Do consolidation loans involve risk?
Almost every financial product involves some degree of risk – and consolidation loans are no exception. Here are some things you’ll want to know if you’re looking to consolidate debt.
- When you consolidate debts with a secured loan, whatever you use as collateral may be seized by your loan provider if you default on repayments. This is a risk you might not be familiar with if your current debt involves only unsecured loans.
- Debt consolidation loans won’t protect you from unwise spending. Therefore, if you spend the funds from your consolidation loan on other purchases, you might end up with greater debt.
- Even if you take out a consolidation loan, your new lenders might not have the power to prevent your home from being repossessed. Before you sign on for a consolidation loan, please check through all the terms and conditions and consider everything thoroughly.
- Never trust any loan providers if you aren’t 100% sure they are legitimate, legal lenders. Warning signs of an illegal consolidation loan provider may include:
- requiring you to sign blank paperwork;
- no details are given around repayments;
- lack of clarity and transparency, or lack of documentation regarding interest rates and fees;
- over-hasty transactions; and
- the lender is encouraging you to sign up for a business loan, yet you only need a regular personal loan.
Things to consider when you want to consolidate debt
In Australia, we are lucky to have access to a wealth of free resources and support when it comes to refinancing. Some great sources of information, assistance and guidance are:
- Ombudsmen – Where you have any doubts regarding the transparency or legitimacy of your consolidation loan provider, it is free to lodge a complaint to an ombudsman. Your lender is not permitted to take any legal action against you while your complaint is being processed. Once your case has already been decided by a court, however, the ombudsman cannot assist you anymore.
- Legal Aid – Australia has offices and centres for legal aid in all territories and states. These can be an excellent place to seek financial advice at no cost.
- Financial counselors – these financial specialists can help you organise your assets, funds, and liabilities. In some instances, a financial counselor might even be able to negotiate what you owe with your loan provider.
Important pointers for consolidating your debt
Finding a consolidation loan that will really benefit you involves more than just choosing the loan with the lowest interest rate. Here are some pointers and questions to think about:
- Penalties and fees can make a big difference. Establishment fees, early repayment fees, valuation, and other charges may add up to make a low-interest consolidation loan more costly. If you want to repay your debt consolidation loan early, a consolidation loan that charges additional repayment fees won’t be ideal. Also, look out for additional charges like stamp duty if you’re going to put up collateral for a secured consolidation loan.
- Longer repayment periods may cost more overall. You may be looking at debt consolidation to make your monthly repayments more manageable. If so, remember that longer repayment periods also mean more interest payments over time. This means that even a consolidation loan with a lower monthly interest rate might cost more in the long term.
- Is the loan provider licensed? In Australia, the ASIC Connect Professional Registers contain a record of all licensed loan providers. If a credit provider doesn’t appear on this register, they are not legally in a position to offer you a loan.