Pros and cons of debt consolidation

What is debt consolidation?

‘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. Debt consolidation can save money and simplify life, but only as long as we’re not running up even more debt in the meantime! So there are risks.

The benefits of consolidating debt

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. 

The risks of consolidating your debt

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

Borrowing to make ends meet or struggling with debt? Try our debt calculator.

Extending your mortgage could be an alternative option

If you’re a homeowner 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 your mortgage.

To make this work you’d need to increase your 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 you pay back will be higher.

The best option is to make the mortgage repayments the same as the total repayments for all your loans. Then because mortgage interest rates are lower, you’ll pay the total off quicker. 

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