Guides

Your Guide to the Benefits of Debt Consolidation

A debt consolidation loan helps you get a clearer picture of your financial future. By bringing all your existing debt – such as student debt, credit cards or store cards – together into one new debt, you can manage your repayments better and probably save yourself some money along the way. 

If you have multiple debts, managing all your monthly repayments can feel overwhelming. Debt consolidation loans let you roll all of your debts together and pay them off together ­– in one handy payment and usually at a more competitive interest rate.

You'll no longer have the hassle of multiple monthly payments and you also might be able to make early repayments if your bank balance is looking healthy. This may mean you can pay down your debt faster, helping you save in interest and getting you out of debt sooner.

So don’t think of debt as a dirty word.  It’s money you’ve used to help you get where you are or what you want. The important part is to be in control of your debt.

Of course, there are some important things to think about when considering consolidating your debt.

  • How much do you need? Gather up all of your outstanding debt and add it up. This is your existing debt and the amount you’ll need to borrow. Don’t forget to include any fees and charges that might apply.  
  • How much are you currently paying? This will give you an idea of how much you can afford in repayments and help you understand what you might save by consolidating your debt.
  • How long will you need to repay? It’s time to do some maths. Divide the loan amount by your monthly repayment to get a ballpark amount of the time it will take to repay the loan.
  • Decide between secured or unsecured? Are you confident in your ability to repay the loan and own an asset of value? If you’re willing to put up security against the loan, you can consider a secured loan. This will get you a better rate, however, the lender has the right to sell your asset if you can’t repay the debt.
  • Fixed or variable? Do you want to know how much your loan will cost down to the cent, or are you happy to ride the waves of the market for a possible saving of a lower rate? Consider whether a fixed or variable interest rate would be best for you.

Whether it’s a personal loan for holiday or a personal loan for debt consolidation, all loans have the same building blocks. It’s about finding the right fit for you.

Interest rate

Money costs money. So when you borrow it, you need to pay it back with interest. The interest rate, also known as Annual Percentage Rate (APR) or Advertised Rate, is the percentage that you’ll pay on top of the amount you borrow. It’s usually expressed as an annual rate. How is interest calculated? To work out your rate, lenders will factor in things like your credit history, your repayment schedule, the risk (both for lending to you and how the market is going) and their underlying costs.

Most lenders start with a headline advertised rate – the lowest rate they have available. But they might not offer you this rate – it’s usually only available to a small proportion of borrowers and may come with set conditions to qualify (e.g. a high credit rating plus homeownership).

So, it pays to do your research. Before you apply anywhere, get a personalised rate from a number of providers. Just be sure that the lender’s quote process is ‘credit score friendly’. That is, they only conduct a soft check on your credit file which won’t impact your credit score.

And remember, the lowest interest rate might not be the best loan. Be sure to consider the total cost of the loan including interest, fees and other costs to truly assess the value of any interest rate on offer.

Comparison rate

Interest isn’t the only cost of a loan – it will usually come with fees and other charges. These can be quite significant and quickly outweigh a great rate. To avoid getting caught out, look at the comparison rate, which factors in the interest rate and any fees, expressed as an annual percentage. The comparison rate is usually higher than the interest rate charged on the loan.

Because it’s so important, lenders and brokers must provide a comparison rate when they advertise a loan interest rate under the National Consumer Credit Protection Regulations.

How is it measured?

For personal loans, there is a standardised measure for how comparison rates are to be calculated and displayed. For variable and fixed rate personal loans, the comparison rate is based on a $30,000 unsecured loan over 5 years.

But there’s a catch – not all costs are included. So you don’t get an unwelcome surprise later, you still need to factor in:

·       Late payment fees

·       Break costs or early termination fees

·       Deferred establishment fees

·       Broker fees (when taking out a loan through a broker, the broker’s service fees aren’t included in the comparison rate, which can be significant).

Repayments

You’ve got all your ducks in a row and consolidated your debt into one loan. Now it’s time to repay the money. During the loan process you’ll agree to a regular schedule for repayments – either weekly, fortnightly or monthly. Factor these repayments into your budget (and be sure that your loan repayment calculations have been quoted inclusive of any ongoing fees).

Your lenders might also offer a balloon payment – a lump sum repayment you make at the end of the loan term. It can reduce your regular repayments, making it a handy way to manage your cash flow. But remember, the lump sum is due at the end of the loan, so you still need to find the money along the way. You’ll also be paying interest on a higher loan balance as you go.

Upfront fees

Also known as application or establishment fees, they’re ‘one-time’ charges at the start of a loan that get the ball rolling. They can include:

·       A flat fee (e.g. $499) that applies regardless of the value of the loan

·       A tiered fee (e.g. $250, $500, $750) based on the value of the loan

·       A percentage fee (e.g. 3%) based on the total amount borrowed and the credit or risk profile of the customer

·       A hybrid fee (e.g. $200 + 2% of the loan amount).

Your lender may charge any or all of these, it’s up to them.

But, fun fact, even though they’re called ‘up front’, that’s not when you pay them. Establishment fees are usually capitalised to the loan, meaning they’re added to your loan.

It’s important because they increase your total loan amount. That means you’ll be paying interest on those fees (as part of your total loan). The difference might be only a few dollars on each repayment, if it’s a small upfront fee. But if it’s bigger, it can quickly add up.

Monthly or ongoing fees

Ongoing fees, also known as account keeping or loan management fees, are usually paid monthly across the life of a loan. They don’t reduce what you owe at all, they just go straight to the lender. Generally the lower the fees, the better. But again, it’s all relative to the total amount you repay when you factor in all interest payable and costs.

Brokerage fees

If you use a broker to help track down your loan for you, remember they’re doing a job. And that means you’re paying them, whether you realise it or not.

In the case of personal loans, the brokerage fee is often capitalised to the loan amount and is in addition to the lenders own upfront fee. Brokers can also have commission arrangements with lenders that are either built into your interest rate or offer them a return based on the final rate you accept. So just be sure to factor that in when deciding if their services are worth it.

Penalty fees

Nobody ever takes out a loan expecting to pay penalty fees. But life doesn’t always go to plan. The best you can do is try and minimise the damage.

The most common penalty fee is the ‘default’ or missed payment fee. If you make a payment late, or there are insufficient funds in your nominated account on the day a payment is due, you can get slugged with this fee.

Late fees vary from $10 to as much as $35. Some lenders may waive the fee if your account is brought up to date within 3 days of a missed payment, but it’s best not to risk it. So be sure to keep an eye on your spending and make sure you have enough in your account to pay the loan. You could even set up a separate account dedicated to paying your loan.

Early repayment fees

If you think you want to pay your loan down ahead of schedule, look for a loan with low or no early repayment fees. Otherwise all your hard work may go to waste if you get charged for it.

Exit fees or early repayment fees are more common with secured low-rate loans. There are different types:

·       A fixed fee where the loan is repaid in full any time prior to the end of the loan term (e.g. $500)

·       A fixed fee where the loan is repaid in full prior to a minimum period (e.g. $250 if full repayment is made less than 2 years into a 5-year loan)

·       A variable fee based on the amount you would have paid in interest and fees had the loan run to full term.

Loan amount

How much money do you need to repay your existing debt? Add it up and that’s your loan amount (plus those upfront fees). This is the principal part of your loan that you’ll make repayments on. Interest is charged on the outstanding balance of your loan.

In Australia, debt consolidation loans usually range from $2,000 to $50,000, but some lenders will go higher.

Loan term

A debt consolidation loan gives you the space you need to pay off your debt over time. In Australia, lenders offer loan terms between 1 and 7 years, with 3, 5 and 7 year terms being the most common.

If you’re tempted to take your time, just remember, a longer-term loan might have a higher interest rate and the loan will cost you more overall. But when it comes to cash in the bank, your monthly repayments will be lower. Do your sums and choose what’s right for you.

Customer experience

Not technically part of your loan, but it’s the X factor that can make all the difference on your journey to financial freedom. Because the best way to consolidate debt into one payment is with a lender that cares.

You want a lender who makes it quick and easy to apply, get approved and manage your loan. And if you have a problem, you want a lender that cares about your experience. It can go a long way towards trusting you’re getting the best deal.

So, is debt consolidation a good idea? 

A debt consolidation loan can affect your credit store, and unfortunately things get worse before they get better. Opening a new credit account temporarily lowers your credit score. Lenders look at new credit as a new risk, causing a temporary dip in your score. But you can fix this by paying your new consolidated debt on time – that should bump it up higher than before.

Taking a long term view, a debt consolidation loan can help you take control of your financial situation, likely paying less interest  - so you can get ahead sooner. 

Related Guides

Back