Is a debt consolidation loan right for you?
A debt consolidation loan allows you to bring a number of different debts, including credit cards, personal loans and even overdrafts, into one new balance.
Rolling these debts into one means you only have to remember one due date, pay one set of fees (if fees are involved). The biggest benefit to most borrowers, however, is that debts with higher interest fees, like credit cards, are suddenly subject to lower rates.
Are debt consolidation loans a good idea?
This depends on what your circumstances are. There are a few situations in which consolidating your debts can work well.
If you’re juggling several due dates each month
Having several dates each month makes it more likely that you’ll miss one payment and get hit by a late fee, which only means that you owe more money. If you reduce these dates to just one, your life is simplified.
If some of your debts have high interest rates
Credit cards tend to have interest rates of around 20 per cent p.a. whereas personal loans have rates as low as seven per cent p.a. so moving a card balance can be much cheaper.
If the maths works in favour of a debt consolidation loan
While debt consolidation loans have lower interest rates, you could be paying the loan off for longer. It’s important to make sure that the longer repayment period won’t cost you more in interest than you’d pay if you could clear your debts in a shorter period of time.
Do debt consolidation loans harm your credit rating?
In general, a new loan will only harm your credit rating if you don’t meet your payments.
Any application you make for a new loan will show on your credit history, so if you’re rejected it can leave a negative footprint. If you’re approved, you’ll be lowering your credit utilisation, which is usually good news. However, it can also mean you have more credit available to you, which might be a problem.
You should compare debt consolidation loans
The purpose of a debt consolidation loan is to make your payments more convenient and, hopefully, more affordable. While most loans of this nature will do just that for you, you should still take time to compare the products available to make sure that you pick the best one for you.
Which type of loan do you need?
You could opt for an unsecured loan, in which case you won’t have to offer any assets as security against the debt. You’ll get slightly higher fees and interest than you would with a secured loan, but none of your assets are at risk of repossession if you default.
A secured loan will usually mean a lower interest rate, but in return, you have to offer the lender an asset as security. If you fall behind on your payments, you could lose the asset.
Then, there’s the choice between fixed and variable interest rates.
With a fixed interest rate debt consolidation loan, your payments will stay the same for the duration of the loan, which makes it easier to budget. However, fixed rate loans often have high early repayment fees and often don’t allow overpayments.
Variable rate debt consolidation loans tend to have lower interest rates and fees, but these can change at short notice. You’ll probably be able to make overpayments and even early repayments without penalties.
Flexibility can work well
If you think you can make extra payments, even if it’s just an additional $10 each month, then you’ll pay down your balance earlier than expected. This means you’ll be debt–free ahead of schedule and also that you’ll pay less interest over the course of the loan.
A flexible repayment schedule can also speed things up. If you pay fortnightly rather than monthly, you’ll make 26 payments each year. You might think it’d be 24 payments (12 x 2), but there are actually 26 fortnights in a year. In this way, you can actually pay off an extra month without really feeling it.
What not to do with a debt consolidation loan
Forget about hidden fees
The headline interest rate isn’t the be–all and end–all when it comes to a personal loan. Many loans have set–up and application fees, as well as some having monthly management fees.
Ongoing fees might be as little as $10 each month, but that’s $120 a year or $600 over the course of a five–year repayment period. Could you put that $600 to better use? If you can find a loan with smaller fees, or none at all, then you can put the “saved” money towards repayments.
Variable or fixed rates and their associated exit fees.
Unlike home loans, Variable & Fixed rate personal loans have little if any penalties for making overpayments or early repayments. Break costs or exist fees are minimal as many lenders don’t charge early termination fees.
Run up more debts
When you take out a debt consolidation loan you might have more money in your pocket at the end of each month due to lower interest rates, but you’re supposed to be paying that debt down.
Try to resist the urge to use the older accounts and cards. You may well be paying an annual fee for a credit card even if you’re not using it, so shut the account down and use the money to reduce your main debt.