The good news is that if you have a credit card or personal loan debt of $25,000, you can reduce the interest you pay by around $18,000 – or save around $350 a month in repayments. You just need to know how.For most people, managing multiple, smaller repayments wastes time and causes unnecessary stress, and those smaller payments can really add up.
Juggling money to meet each repayment on time, making different transfers at various times of the month and to different lenders is a nuisance: miss one repayment, and you are more than likely to be smacked with a hefty fee. Worse still, most non-mortgage debt attracts interest rates two to four times higher than your mortgage, so it is a big waste of money as well. If this sounds like you, then debt consolidation could be a key step to eliminating your debt and regaining control of your money. It can save you time and money if you get it right.
How it works
Debt consolidation is the combining of outstanding balances of several credit facilities into a reduced number of facilities. Although it is not always possible, the idea is to combine all outstanding balances into a single loan with a lower interest rate. Credit often included in a debt consolidation includes: credit cards, store cards, interest-free deals that have expired, personal loans and mortgages.
For people with equity in property, this often means paying out higher interest credit by taking a top up on their existing mortgage or taking out a new loan against their property. While this may seem a little fiddly and perhaps costly too, the benefits of debt consolidation are many. They include:
having one manageable repayment
lowering your overall minimum monthly repayments
reducing the interest rate from
credit card rates to home loan rates to accelerate repayment
Aside from the above benefits, the primary reason for debt consolidation is to improve repayment manageability and accelerate repayment of your debt. If the main reason for undertaking debt consolidation is to lower your monthly repayments, it could be an early warning sign that you are headed for financial trouble. If this sounds like you, get help from a government support agency in your state or territory before proceeding with a debt consolidation.
Recognising the early warning signs
Difficulties in meeting debt repayments can have a detrimental affect, not only on your bank balance, but on your health, work and personal relationships. Acknowledging you are struggling with mounting debt is the first step to addressing the problem. People undergoing mortgage stress tend to fall behind in their repayments, increasingly use credit cards for day-to-day finances, borrow money from family and friends, and may be on the verge of entering default proceedings.
It’s all too easy to avoid looking at the big picture when it comes to your financial situation: no one knowingly takes out a mortgage expecting to fall into crippling debt, but it is something that can creep up on you unexpectedly. If you are only just clearing your repayments every month, you are not necessarily exempt from having a credit problem. This can lead to a false sense of security, thereby stopping you from properly tackling the situation and getting some professional advice. Whatever the reason, getting a handle on your debt doesn’t have to be something you need to tackle on your own. Just follow our step-by-step guide to getting your finances in shape.
Acknowledge the symptoms, address the cause and stick to a sensible budget to get yourself back on your feet financially – and make sure you stay there
1 Do your sums
Crunch the numbers on your existing debt to give you an accurate comparison between your current multiple loans and taking out the one consolidated loan. Tally up exactly how much you owe, how much interest you pay, how much that debt will cost you one, five, and 10 years from now, and how much money you pay out each month in minimum payments.
Crunching the numbers can be a detailed and time-consuming exercise when done properly, however, specialist tools and knowledge can simplify the process. This is an area where you can benefit from professional advice, and it may be worth seeking help from your mortgage broker. They should have access to the right tools and be able to provide you with a good indication of the costs of different refinance options.
Finally, whether you are topping up your existing mortgage or refinancing and taking out a higher loan, it is unlikely to be free. Add up administration charges and other fees from your lender that may apply to you before making the switch.
2 Maintain the repayments
If you decide to consolidate debt, you should ask your broker or lender to synchronise the debt, but maintain the consolidated debt as a ‘split’ separate to your original home loan. A ‘split’ has its own statements and repayments; however, it has the same interest rate as your main mortgage. This helps avoid one of the biggest problems for most people – out of sight, out of mind.
Once the debt is consolidated it can disappear amid a much larger mortgage and you may inadvertently slip back into bad habits. Consolidating debt as a separate split is a reminder of how vulnerable you are to letting credit get the better of you. It also helps you see how quickly you are or are not fixing the problem.
Your broker should be able to track down and arrange lenders and loans where there is no extra fee or interest cost for this benefit. By synchronising your repayments and statements, the debt remains visible, but the cost and time spent managing and repairing your situation is reduced.
Also, because your new home loan will have a lower interest rate and will be paid over many years, the minimum repayment rate will usually be quite a bit lower than the same debt on a personal loan or a credit card. However, this will extend throughout the loan’s length of time, so despite a lower interest rate, the actual interest cost you pay may be considerably higher than if you left your debt as it was.
So, once your debts have been consolidated, you should try to maintain or increase your total pre-consolidated repayments and direct this repayment to your new debt consolidation split. If you do not do this, you will pay more interest and potentially extend the life of this debt across the full term of your mortgage.
3 Close surplus credit cards
Access to easy credit is potentially a recipe for financial disaster if indiscriminate spending occurs. Consolidating your debt only to continue spending on your credit card is an all-too common trap. You need to think about getting rid of them. If you do keep one, make sure it has at least 40 interest-free days and the limit is no more than the amount you can repay each month. For most people, this should be around three weeks’ net pay. If you think you ‘need’ a credit card, you are in trouble again.
4 Change your habits
Devise a strict budget and stick to it. Look carefully at changing your spending habits by focusing on ways you can save, while seeking out additional sources of income such as part-time work, downgrading the car, and going out less often. Live on less than you make by spending less; you will see a difference. Knowing what to economise on is the key to budgeting success.
5 Traps to avoid
While debt consolidation has its rewards, some experts regard it as a quick fix for a deep-rooted problem. One of the biggest traps is that it fails to diagnose the root cause of why you fell into debt in the first place, so it’s vital for individuals to identify the reason. At the end of the day, borrowers should use debt consolidation hand in hand with a budget. In essence, it is a short-term remedy for a long-standing problem.