What are the different types of debt consolidation loans?

Know your debt consolidation home loan from your fixed-rate unsecured personal loan? You soon will.

Debt comes in many forms. From credit cards to car loans, it can quickly add up. Keeping it under control can be a challenge. That’s why consolidating your debt into just one loan can be a clever idea. It makes life easier with just one loan to pay, and you might even save money on interest, fees and charges. But how do you do it? We talk you through the ins and outs, from a debt consolidation home loan to a shiny new personal loan in all their different forms.

Add to existing debt or start fresh?
When you’re looking at streamlining your finances, you’ll be getting up close and personal with your debt. You might think it’s easiest to simply work with what you’ve got. For many people, that means refinancing their mortgage.

With a debt consolidation home loan, you combine all your outstanding debt into your home loan, essentially increasing your home loan. Just remember, although it makes payments easier, home loans have a longer loan term, so you’ll have a greater number of monthly repayments over time. That means you may end up paying more interest in the long run, costing you more.

If you want to keep your mortgage separate (or you don’t own a home), you can simply take out a personal loan to consolidate your debt.

To secure or not to secure?
If you own something of value like a car, home or term deposit, you can choose to use this as security against a loan. With a secured personal loan, you can usually access a lower interest rate because it’s less risky for a lender to loan you money. You may also increase your borrowing capacity and get a longer loan term. The trade-off is that you give your lender the right to seize your asset if you fail to make repayments.

However, the vast majority of personal loans are unsecured, with no assets used as security against the loan. The lender’s choice to loan you money is based on how creditworthy you are. It’s an educated guess regarding whether or not they think you’ll be able to pay the money back. It’s more risk for them, so you’ll probably be offered a higher interest rate, lower loan amount or a shorter term. But there’s a quicker application and approval process, greater freedom to use the funds and your assets aren’t directly at risk.

Why choose a secured loan?
+  Lower rates
+  Increased borrowing potential 
+  Longer terms available
-  Can take longer to approve
-  Your asset is at risk if you fail to pay

Why choose an unsecured loan?
+  Greater freedom
+  Less borrowing potential
-  Shorter loan terms

And what about fixed and variable rate loans?
Every loan comes with interest, but even then, you still have options.

With a variable-rate loan, the interest rate isn’t locked in. So if the market interest rate goes up, so will your repayments. But on the flipside, when the rates go down, your repayments will too.

If you’re looking for certainty, you can fix your interest at a rate that will remain the same for the life of your loan. You’ll usually be offered a higher interest rate than for variable rate loans. But you’ll know exactly what your repayments are month to month, helping you manage your budget. Plus, If variable rates head north, you’re protected.

Just remember, depending on your lender, you may have less flexibility to make early repayments with a fixed rate. However many online loan providers offer no early repayment fees, regardless of whether your loan is fixed or variable. Be sure to check with your lender before you fix it.

Why choose a variable rate loan?
+  Usually more flexibility to repay your loan early
+ Lower repayments if interest rates go down
+  Rates are competitive
-  Budgeting is harder

Why choose a fixed-rate loan?
+  Know what your repayments will be for the life of the loan
+  Easier to budget
-  More likely to have early repayment fees
-  May be less flexible depending on provider

Anything else to know?
That’s the big things covered. When it comes to personal loans, there are a few other terms you might have heard of.

Fixed-term vs line of credit
With a fixed-term loan, you get the money as a lump sum and agree to pay it off within a certain time period. So you know exactly how long it will take you to pay off your debt.

Alternatively, a line of credit is a type of personal loan that works more like a credit card. You can draw on the funds in the form of an ongoing credit facility and pay off the debt and accrued interest in instalments. The advantage here is that you only pay interest on the money that you actually use, versus the entire amount as would be the case with a personal loan. This is less relevant for a debt consolidation loan. 

Special or limited purpose loans
Some lenders offer personal loans with lower interest rates provided the funds are used for a specific purpose.

Risk-based pricing
Most lenders give a ‘personalised’ interest rate and tailor the loans they offer. They do this through ‘risked-based’ pricing, where the rate provided is based on the probability of a borrower defaulting on a loan. To calculate this, they’ll look at your credit history, financial situation, the loan type, the loan amount and a range of other factors that are used to build your unique risk profile.

If you’re considered ‘low-risk’ and more likely to pay back the loan, you’ll be rewarded with a lower rate. If you’re ‘higher risk’, expect to get a higher rate.

Risk-based pricing has become more common with the introduction of comprehensive credit reporting (CCR). Credit providers are now required to include extra ‘positive’ information such as the type of credit you hold, the amount of credit and whether you pay your bills on time. In the past, credit reports only showed negative credit events or ‘black marks’ (e.g. missed payments or defaults), rather than giving an overall picture.

The choice is yours
When it comes to choosing which loan type is right for you, ask yourself:

What’s the interest rate like? Before choosing your loan type, you should compare debt consolidation loan rates to find the lowest possible rate available

Do you prefer a fixed or variable rate?

• What’s the interest rate like? 
• Before choosing your loan type, you should compare debt consolidation loan rates to find the lowest possible rate available
• Do you prefer a fixed or variable rate?
• Can you realistically make repayments on time?
• What is the length of the loan?

Don’t forget to factor in any fees and charges. Once you have the big picture, you can work out how much you’ll likely save by consolidating your debt into one loan.