Consolidating debt

Consolidating’ debt means taking out a new loan to wrap all our existing debts together and pay them off at once – ideally at a lower interest rate so we get out of debt faster.

• The benefits
• The risks
• Increasing the mortgage

The benefits

Having trouble keeping up with several high-interest loans? It might be worth rolling them into one.

Debt consolidation loans usually have a lower interest rate and tend to be spread over a longer period – so the weekly or monthly payments are smaller.

Debt consolidation can make budgeting easier because there’s only one loan to manage.

We’ll often pay a lower interest rate with a consolidation loan than we would with hire purchase and credit card debt.

However, debt consolidation won’t help if we continue to take on new debt. The key is to focus on getting rid of existing debt rather than adding to it.

Guide to borrowing

Borrowing to make ends meet or struggling with debt? Budget advisers are on hand to help at 0508 BUDGET.

The risks

Consolidating or refinancing loans can work out well if it means paying less in fees and interest. But there are risks:

• It may be a short-term fix if we can’t meet the repayments on the new loan.
• Lower repayments but over a longer term can add to the overall cost because we’re paying interest for longer.
• There can be extra fees and charges, including ‘hidden’ fees for alterations, late payments and payment defaults. Believe it or not, lenders may even charge extra for paying off existing loans early.
• Companies specialising in debt consolidation may charge higher interest than a bank. Talk to the bank about what they can offer before signing up with a new company.
• There would probably have been establishment or documentation fees paid on the original loans. Taking out a debt consolidation loan adds another set of fees, which could cost hundreds of dollars.

To reduce the risks, we can find out the total cost of consolidating before signing up. Shopping around and reading all the fine print helps.

Increasing the mortgage

An alternative option for homeowners to consider could be extending the mortgage.

For someone with a number of loans that charge high interest rates — like a car loan at 15% or a credit card at 19% — it could be cheaper to pay those off by increasing the mortgage.

To make this work we’d need to increase our repayments so that the mortgage payoff date stays the same. Just remember that because the new lending is being paid off over a longer period, the total we pay back will be higher.

Ideally we’d make our repayments the same as the total repayments we were making on all our loans. This way, because mortgage interest rates are lower, we’ll pay the total off quicker.

Guide to managing a mortgage