How to consolidate your debt through a personal loan

author-avatar By on February 11, 2021
How to consolidate your debt through a personal loan

If you’ve got multiple debts to your name and want a simpler way to repay them all, a debt consolidation loan could be the answer.

A debt consolidation loan essentially combines all your different debts (such as credit card debts and personal loan debts) into the one loan with one simple repayment.

This makes managing your debt easier, but before you consolidate your debt there are things to consider first.

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What is a debt consolidation loan?

A debt consolidation loan is a type of personal loan that allows you to roll many different types of debts (like credit card debt, personal loan debt, etc) into a single loan so that you only have one monthly repayment to remember with a potentially lower interest rate.

While this method can make it easier to manage multiple debts, it can also backfire if you end up stretching out your debts with a longer loan term and as a result end up paying more in interest than you would have if you’d just paid off your debts in the original loan term/s. This is more often the case if you consolidate your debts into a home loan, but it can also happen with personal loans if the new debt consolidation loan term is longer than the original loan term.

Advantages of consolidating your debt through a personal loan

  • Consolidating all your debt into a single loan makes managing your debt easier because you only have one monthly repayment to make.

  • You could potentially get a lower interest rate.

  • Rolling all your debt into one loan means you could have fewer account keeping fees to worry about.

Disadvantages of consolidating your debt through a personal loan

  • If you fail to make the repayments on time, you could end up increasing the amount of debt you owe through late payment fees and incurring further interest.

  • You may need to pay break costs for exiting any existing loans.

  • If you don’t keep up with your repayments, you could damage your credit score.

Do’s and don’ts of debt consolidation loans

DO shop around and compare debt consolidation loans to find one with a competitive interest rate and terms and conditions that will work for you. Don’t forget to look at the comparison rate when comparing loans, as this is often a better reflection of the cost of the loan because it takes fees into account.

DO look for a debt consolidation loan with flexible features, such as the ability to make extra repayments without being financially penalised, and flexible repayment frequency.

DO remember to factor in all the costs before consolidating your debt into a single loan. There are establishment fees, early repayment fees, loan application fees, potential break costs for existing loans, and other fees. You may even find that it’s not financially prudent to consolidate your debt because doing so could end up costing you more than if you continue paying your current loans.

DO set up automatic payments so that you never forget your monthly or fortnightly repayment. You can easily set up automatic transfers through your online banking app to your lender. You can time your automatic payments to coincide with payday, that way your debt gets paid off in the background and you don’t even have to think about it.

DON’T roll your debts into your mortgage (at least, think VERY carefully before you do this). Mortgage repayments have very long loan terms (25-30 years) and stretching out your short term debts into such a long loan term could see you paying thousands more in interest and fees.

DON’T switch to a longer loan term without considering the financial implications. While this can make your monthly repayments smaller, you could end up paying much more in interest and fees over the life of the loan than you would have if you’d just paid off the debt within the original time frame.

DON’T take out more debt. If you’ve already got credit card debt or personal loan debt, don’t apply for more credit cards or payday loans to get you through. Going into even more debt to repay your existing debt can present itself as a ‘stop gap solution' but doing so can trap you in a debt spiral. If you are really struggling to get on top of your debts, there are other options which we’ll cover later.

Other ways to consolidate your debt

Besides consolidating your debt through a personal loan, there are two other common methods of debt consolidation:

Credit card balance transfer

For those of you with credit card debt across multiple cards, you could consolidate all that debt onto a single card using a balance transfer.

Under this method, your credit card debts will be moved onto one card with a lower interest rate, or even a 0% interest rate, for a limited time (the promotional or honeymoon period) which can be between three and 26 months. In theory, you should aim to repay all your debt without incurring any further interest for that honeymoon period.

But if you don’t manage to repay all the debt before that period has ended, any debt that hasn’t been paid off will then be charged at a revert rate, which is usually far higher than most credit card interest rates. For example, most credit card interest rates sit around the 17% mark, while the average revert rate is 20% and can even be as high as 24% in some cases. An ASIC review found that 30% of balance transfer users ended up increasing their debts by 10% or more because of this - not really the ideal outcome when the whole point of a balance transfer is to get rid of your debt, not get further into it.

Consolidating debt into your home loan

The other popular method of debt consolidation is to roll all your debts into your mortgage. To package up all their existing debts into their mortgage, many homeowners refinance their home loan to a bigger loan or apply to increase their existing home loan. That way, all their debts get gradually paid off through their regular mortgage repayment.

An advantage of this strategy is that most home loans these days have very low interest rates of between 1-3% - compared with interest rates on personal loans and credit cards which are around the 17% mark. While it may seem like a no brainer to consolidate your credit card and personal loan debts into your low-rate home loan, this can backfire because mortgages have very long loan terms, usually between 25-30 years. Stretching out short term credit card and personal loan debts into such a long loan term means you may end up paying thousands more in interest and fees over the life of the loan.

If neither of these methods appeal to you and you would rather tackle your debt without consolidating it, there are some other debt reduction strategies such as the ‘snowball strategy’ or the 'avalanche strategy'.

Does debt consolidation hurt your credit?

As with any other type of loan, a debt consolidation loan should only negatively impact your credit score if you fail to make the repayments on time. If you’re on time with repayments, a debt consolidation loan shouldn’t have a negative impact on your credit.

When you apply for a debt consolidation loan, it will appear on your credit report as a hard inquiry. Too many hard inquiries (too many applications for loans) will negatively impact your credit report which is why it’s important not to apply for too many loans at once.

Generally speaking though, demonstrating that you can consistently meet loan repayments over a period of time can help establish a positive repayment history which can actually help your credit score. This is because many banks in Australia are now required to use comprehensive credit reporting (CCR) which gives lenders a more complete picture of a borrower’s abilities by noting their good behaviours (such as making regular debt repayments) on their credit report.

Can you get a debt consolidation loan with bad credit?

If you have a bad credit history, you may find it more difficult to get approval from a lender for a debt consolidation loan. However, there are some lenders out there who may approve debt consolidation loans for people with bad credit. However, you may have to pay a higher interest rate than borrowers with good credit scores, which could actually end up being more expensive.

How to get help if you’re struggling with debt

If you’re really struggling to make your debt repayments, there are plenty of resources available to help you out:

Your credit provider

Ask your lender what financial hardship options they have, such as a payment plan or the option to change the condition of your repayments to make them easier for you to keep up with. Lenders have hardship departments to help you manage your loan repayments so don’t be afraid to reach out.

National Debt Helpline

The National Debt Helpline is a not-for-profit service that offers free financial counselling to help you get back on track if you’re deep in debt. The financial counsellors can help you by assessing your financial situation, give advice on how to deal with your lender, and can help you work out a realistic payment plan for your debts. You can reach out to the National Debt Helpline on on 1800 007 007 or online on weekdays from 9:30am to 4:30pm.

Lifeline

Being in financial difficulty can also have an impact on your mental health. If you’re really struggling and need someone to talk to, you can reach out to Lifeline on 13 11 14 over the phone or online at any time of the day or night.

Savings.com.au’s two cents

Debt consolidation has its merits because it can make managing your debt much more simple as there’s only one loan repayment to worry about, rather than juggling multiple loan repayments across different debts. If debt consolidation isn’t right for you, there are other debt reduction strategies you can try, such as the snowball method or avalanche method we’ve linked to above.

If you can’t see any of these options working, don’t be afraid to reach out to your current lender and ask them what financial hardship options they offer. DO NOT take out any more debt to try and manage your current debt. Payday loans and credit cards can seem like a ‘stop gap solution’ but taking out even more debt to manage your current debt will only lead you into a debt spiral - it’s just a recipe for disaster.

Once you have worked your way out of debt, it’s extremely important to sit down and analyse what led you into that debt in the first place so you don’t fall into the same situation again. Create a budget and consider cutting up your credit cards so that you’re not tempted to pay for future expenses using your card. If you’re the type of person who has trouble controlling their impulse spending, cutting up your cards is probably a good idea.


Photo by Nataliya Vaitkevich from Pexels

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Emma Duffy joined Savings.com.au as a Finance Journalist in 2019 after spending a year as the editor of The Real Estate Conversation. She's passionate about empowering people to make smart financial decisions and improve the financial literacy of Australians by translating complex finance topics into understandable, relatable content.

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