- Debt consolidation loans allow borrowers to roll all their debts into their refinanced home loan
- This can see them pay less interest as home loan interest rates tend to be lower than those on other credit products
- But debt consolidation loans need to be weighed up against refinancing costs and other potential pitfalls
Consolidating existing debts is a common reason for Australians to refinance their mortgages.
From credit cards to personal loans, it can be easy for some people to rack up multiple sources of debt. But If you've got a home loan, rolling other debts into your mortgage can make repayments easier to manage, not to mention potentially saving you interest.
Debt consolidation home loans
Debt consolidation home loans involve packaging your existing debts (credit cards, car loans, personal loans etc.) into your mortgage.
In simple terms, you refinance your home loan, borrowing extra funds that you use to pay everything else off. Instead of juggling several separate loans simultaneously, you just need to make one weekly, fortnightly, or monthly mortgage repayment.
This can also mean you can reduce your interest bills as home loan rates tend to be considerably lower than those offered on other credit products.
Debt consolidation: a case study
Before
Con Solidaté has a home loan, a car loan, and a credit card bill, all of which are quickly adding up.
Debt | Amount outstanding | Minimum Monthly repayments |
|---|---|---|
Home Loan (7% p.a.) | $600,000 | $3,992 |
Credit card (17% p.a.) | $5,000 | $125 (at minimum repayment of 2.5% of the balance) |
3-Year Car loan (8% p.a.) | $15,000 | $480 |
Total | $620,000 | $4,597 |
Given that Con's after-tax monthly pay is $7,600 ($125,000 gross salary), his total debt repayments account for 60% of that. When he factors in his utility bills, groceries, and other costs such as transport, he doesn't have much left to save.
After
Con speaks to his lender about refinancing his home loan to consolidate his debts. He's six years into his 30-year $800,000 mortgage, with $600,000 remaining.
Since he has a strong equity position with a loan-to-value ratio (LVR) of under 80%, his lender agrees to add the $20,000 of credit card and car loan debt to his mortgage and allows him to refinance to a $620,000 30-year mortgage at the same interest rate of 7% p.a.
His monthly repayments now look like this:
Debt type | Amount owed | Monthly repayments |
|---|---|---|
Debt Consolidated Mortgage (7% interest rate) | $620,000 | $4,125 |
Under this new debt consolidation loan, Con's monthly repayments have now been reduced by over $470 to $4,125, giving him some much-needed wiggle room at the end of every month.
The trade-off is that he will be paying off his home loan for longer, given his loan term is back to 30 years after he'd already been repaying the original loan for six years.
See also: Extending the loan term when refinancing a home loan
Consolidating debts into mortgage
What you'll need
There are a couple of things you'll need if you want to pursue a debt consolidation home loan:
- Equity
In order to top up your existing home loan into a new one that allows you to consolidate your debts, you will need to have some built up equity in the property.
Because of the extra risk you may present, lenders will look to the value of the property to determine your equity, and they'll usually allow you to borrow up to 80% of the value of the property. The more of your mortgage you've paid off already, the higher your chances of being approved for a favourable new loan.
- Borrowing power
If you want to extend your home loan, your lender will likely need to assess your financial situation again. Just as when you initially borrowed, you might need to show your expenses, as well as your income, to demonstrate you will be able to keep paying the loan.
See also: Home Loan Borrowing Power Calculator
How to consolidate debts into your mortgage
Refinancing may seem complicated, but it's a pretty simple concept: you either change to a different loan with your existing lender or switch to a new provider with more favourable terms.
If your current lender agrees, you may be able to just 'top up' your existing loan. In the event your lender isn't willing to do that, it's worth checking what other lenders can do. The table below is a good place to start:
| Lender | Home Loan | Interest Rate | Comparison Rate* | Monthly Repayment | Repayment type | Rate Type | Offset | Redraw | Ongoing Fees | Upfront Fees | Max LVR | Lump Sum Repayment | Extra Repayments | Split Loan Option | Tags | Features | Link | Compare | Promoted Product | Disclosure |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
5.94% p.a. | 5.98% p.a. | $2,978 | Principal & Interest | Variable | $0 | $530 | 90% |
| Promoted | Disclosure | ||||||||||
5.89% p.a. | 5.80% p.a. | $2,962 | Principal & Interest | Variable | $0 | $0 | 80% |
| Promoted | Disclosure | ||||||||||
5.99% p.a. | 6.02% p.a. | $2,995 | Principal & Interest | Fixed | $0 | $0 | 60% |
| Promoted | Disclosure | ||||||||||
5.93% p.a. | 5.93% p.a. | $2,975 | Principal & Interest | Variable | $0 | $395 | 70% | Disclosure |
The home loan market is competitive and there is no shortage of options out there that may offer better interest rates, fees, features, and lending conditions than what you might have.
Some lenders may also offer cash back or other promotional offers in a bid to lure refinancers. While the prospect of upfront cash can be appealing, be sure to consider how other aspects of the loan stack up against your needs.
Pros & Cons of debt consolidation loans
Pros
- Can save you money: Home loans tend to have much lower interest rates than other credit products, saving you considerably on interest charges
- Simplifies debt repayment: Paying one loan cuts paperwork, admin, time, and stress compared to keeping track of multiple loans
- Improves cash flow: Similarly, having just one loan can free up cash flow and help with budgeting
- Can improve credit score: Consistently paying off one loan can boost your credit rating over time
Cons
- Costs and fees: Upfront fees, application costs, and possible early exit penalties on old debts can add up, perhaps making it a more expensive option
- Turning short-term debt into long-term debt: Some debts, such as car loans, may be best getting paid off over their shorter terms (generally one to seven years) even if the interest rates are higher. This may be a better option than than being rolled into a longer-term home loan
- Extended home loan term: Refinancing to a new home loan may see you reset your loan term, that is, restarting with another 30-year term when you have already been making repayments for some years. This strategy may suit some needs but won't be the best option for all refinancers
- May affect your credit score: Applying for a new loan will have an effect on your credit score, albeit temporarily
- Potential to create more debt: Consolidating your debts may be a band-aid solution if underlying issues of poor spending and borrowing habits are not also addressed
To refinance or not to refinance
Before making any decisions on whether to seek a debt consolidation loan, you'll need to consider the costs of refinancing.
Savings.com.au's Cost of Refinancing Calculator can give you a rough guide.
Savings.com.au's two cents
Debt consolidation can certainly make it easier to manage your debts, but it isn't a get-out-of-jail-free card. If you roll all your debt into your home loan and then keep borrowing irresponsibly, you'll likely end up exactly where you started.
It's always worth looking at your spending behaviour first to work out how you ended up where you are and do your best to address any underlying issues.
Be aware too that some lenders might try to charge a higher interest rate when you refinance. This is be because all your extra debts can make you appear to be a higher-risk borrower.
In some cases, signing up to a higher interest home loan could also cost you considerably more in interest over the longer-term than juggling several shorter-term loans. And then there is the matter of upfront refinancing costs to consider which could add considerable expense.
Alternatives to debt consolidation home loans
If you're unable to top up your home loan, or don't even have one, there are a couple of other strategies experts suggest if you're facing overwhelming debts.
The 'snowball' method
Many money experts around the world advocate for the 'snowball' or 'domino' method of focusing on paying off debts one at a time, starting with the smallest debt.
You make minimum repayments on all of your other loans while putting all you can into paying off your smallest debt. Once that's paid off, you move on to the next smallest and keep on going until you're debt free.
This method plays into psychology - the borrower gains more confidence in their debt-repayment abilities after the "quick wins" of paying off the smaller debts, motivating them to tackle the bigger debts.
The 'avalanche' method
The avalanche method involves paying off the debts with the highest interest rates first. This is pretty similar to the 'snowball' method given smaller debts (e.g. credit cards) tend to have higher interest rates than larger debts (e.g. home loans).
See also: Pay off debt, save, or invest first? How to decide.
Get help
If things have taken a turn for the worse, you can call the National Debt Helpline on 1800 007 007 to talk through what your options are.
The Debt Hotline is free and confidential, and you can discuss your individual situation with a financial counsellor who will be able to outline your options.