When you’re looking to streamline your finances or need a little help making a big idea happen, getting a debt consolidation loan is personal. Everyone is different, which means when it comes to finding the best loan, it’s not one size fits all. The best debt consolidation loan for someone else may not be the best deal for you.
So how do you compare the market?
When you’re taking stock of your new approach to your debt, think about:
your current debts and expenses you’d like to consolidate with the loan
your credit score, income and assets
your ability to repay a particular amount off the loan each month
This information will help you assess how a loan meets your individual needs. And from there, there are 5 main ways to compare one debt consolidation loan to another, helping you compare apples with apples – so you can be confident you’re choosing the best loan for you.
Let’s take a look.
1. Type of Loan: Unsecured v Secured Debt Consolidation Loans
There are two types of debt consolidation loans – secured and unsecured. The difference between them is about what you bring to the table to help reduce the risk of your loan for your lender. And that can affect the loan amount, length or interest rate they’re willing to offer. So when you’re deciding on the best loan for you, it’s important to make sure you’re clear on your options and what they mean to you.
What is a secured debt consolidation loan?
If you already own something of financial value, like a car, home or term deposit, you can use this asset as security for a loan. It means that in the unlikely event that you’re unable to make your repayments, you give the lender the right (usually in the form of a mortgage, caveat or charge) to seize and sell your asset to cover the cost of the loan.
Because of this, secured loans are less risky for lenders. And that often means a lower interest rate for you. It may also allow you to borrow a larger amount or for a longer period than would be available to you if the loan was unsecured.
However, some secured loans have special rules about how you can use the funds and what for. It’s so the lender can be sure that the asset’s loan to value ratio (LVR) is enough to cover the outstanding value of the loan if things go wrong.
What is an unsecured debt consolidation loan?
While there are benefits to a secured loan, the vast majority of debt consolidation loans are unsecured. With an unsecured loan, no assets are used as security against the loan. In this case, a lender will decide whether or not to provide you with a loan based solely on how creditworthy you are. Put simply, they’ll consider how likely you are to make your repayments on time or default on the loan. Part educated guess, part trust, unsecured loans are a bigger risk for the lender, so they may offer you a loan with a higher interest rate or a lower amount.
Which loan is right for you?
Secured debt consolidation loan
Usually lower rates on offer. Increased borrowing capacity.
Potential to lose the asset if you're unable to repay. Approval process is often longer with more requirements. You may be restricted as to what you can use the loan funds for.
Unsecured debt consolidation loan
Quicker application and approval process. Greater freedom to use the funds. Your assets are not directly at risk.
Interest rates can be higher. Your borrowing capacity may be lower. You may only be eligible for shorter loan terms.
2. Interest Rates
When you get a loan, you’re responsible for repaying more than just the amount of money you borrowed. You also have to pay interest – it’s essentially the cost of borrowing. The interest rate, also known as Annual Percentage Rate (APR) or Advertised Rate, is the percentage in interest that you’ll pay on top of the amount you borrow. You’ll usually see it as an annual rate.
Interest rates vary depending on the lender, your credit history, your repayment schedule and a range of other factors. There’s a bit of science to it, but they’re typically based on the lender’s calculation of risk (for you as an individual and the market as a whole) and their underlying costs (because it costs a lender money to give you money).
But when you’re considering a lender’s rate, you need to dig a little deeper.
Many lenders market their products using a ‘headline’ advertised rate, which is the best rate they’re able to offer a customer. Often this low rate is available to only a small proportion of borrowers – it may not be the rate they offer you. There also may be other costs associated with your loan and, depending on your loan agreement, the interest rate you pay may change.
To level out the playing field, a good starting point is to look at a lender’s comparison rate.
What is a comparison rate?
Strangely, the lowest interest rate doesn’t necessarily mean the best loan. You need 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.
This is where the comparison rate comes in. It represents the overall cost of a loan, including the interest rate and fees, expressed as an annual percentage. As a result, the comparison rate is usually higher than the interest rate charged on the loan. Under the National Consumer Credit Protection Regulations, lenders must provide a comparison rate when they advertise an interest rate.
How comparison rates are calculated
For debt consolidation loans, there is a standardised measure for how comparison rates are calculated:
Length of loan
For loans 3 years and under
Comparison rates are calculated on a $10,000 loan amount over 36 months.
For loans 4 years and over
Comparison rates are calculated on a $30,000 loan amount over 60 months.
While the comparison rate is a handy way to compare the same for the same, it’s important to remember that not all costs are included. For example, you still need to consider late payment fees, early repayment fees and deferred establishment fees.
You should also remember that interest rates aren’t set in stone – they can and do change over time. However if you’re looking to lock in your interest rate, you may be able to choose between a fixed and variable interest rate.
What is a fixed interest debt consolidation loan?
With a fixed-rate debt consolidation loan, the amount you pay in interest is set from the beginning until your loan is repaid. This means your weekly, fortnightly, or monthly repayments remain the same and won’t change. So you can lock in a competitive rate with the security of knowing your repayments will remain steady regardless of changes in the market. This helps manage a budget.
Fixed-rate loans are typically higher than the current variable rates on offer. But when interest rates are already low, locking in a fixed-rate can protect you from any future rate increases due to changes in the lender’s funding or how the economy is going. Because no one has a crystal ball.
What is a variable rate debt consolidation loan?
Like the name suggests, with a variable rate debt consolidation loan the interest rate can change or vary over the life of the loan. Variable interest rates can change for a number of different reasons, including market changes and the lender’s cost of funds. They can also vary between loan providers. When rates move down, you benefit from lower repayments. But when rates move up, you’ll need to be able to cover the added costs. This also increases the overall cost of your loan.
Because of this uncertainty, variable rate loans have a lower starting price than fixed loans. And they often have fewer repayment restrictions, so you can make additional repayments or repay your loan early without getting charged an early repayment fee.
Which loan is the best personal loan for you?
Fixed debt consolidation loan
Repayments are set for the duration of the loan
It's easier to maintain a budget. However, early repayments or exit fees are more common and there's less flexibility when it comes to repayments.
Early repayments or exit fees are more common
There's less flexibility when it comes to repayments
Variable debt consolidation loan
Greater flexibility to repay your loan early, often without fees
You'll benefit from any reduction in interest rates
Interest rates are generally lower
Your repayments will change with the market rate, making it harder to plan your finances.
Potential for rates to move up significantly.
How to get the best debt consolidation loan rates
Debt consolidation loan interest rates are a big deal because even a small difference in the rate of interest makes a significant difference over the entire period of the loan. For example, an interest rate of 10% on a $10,000 loan over 5 years will have a total lifetime cost of $x compared to $x with a 12% interest rate for the same amount over the same time period.
It’s also worth remembering that the rate you may be offered on a debt consolidation loan may be higher than the advertised fixed or variable rate. The lender will usually decide your interest rate based on your credit score, income, expenses, and assets. A variable option may initially seem better, but once you’ve received a personalised rate estimate a fixed rate debt consolidation loan may have a lower rate, and vice versa.
So before you apply for a loan, it pays to do your research and get a personalised rate from a number of providers. You just need to make sure that the lender’s quote process is ‘credit score friendly’. That means they only conduct a ‘soft-check’ on your credit file that won’t impact your credit score. Also, some providers charge lower interest to borrowers with a high credit score. Getting a loan tailored to your individual circumstances can make a big difference.
3. Fees and Charges
Remember how we said it’s important to factor in the fees you have to pay on your loan? Here’s what you need to look out for and how they can impact your loan.
Upfront fees, also known as establishment fees or credit assistance fees, are ‘once-off’ charges that are applied at the start of a personal loan.
These fees can be a:
flat fee that applies regardless of the value of the loan (e.g. $150)
tiered fee based on the total amount borrowed (e.g. $250, $500, $750)
percentage fee (e.g. 4%) based on:
the total amount borrowed
your credit or risk profile
hybrid fee (e.g. $200 + 2% of the loan amount)
These fees might look small but remember, upfront fees are usually added to the amount you wish to borrow. For example, if you’re borrowing $10,000 with an upfront fee of $300, the total amount of your loan will be $10,300.
Why is this important? Well, you’ll be paying interest on the total loan amount – inclusive of your upfront fee. In the case of a small upfront fee, the difference might be a few dollars on each repayment. However, on an upfront fee of 4%, you could be paying $1,200 on a $30,000 loan, meaning you’ll be charged interest on a $31,200 balance. It makes a big difference to your hip pocket.
So if you’re considering a lender with a low interest rate, be sure to check there isn’t a high upfront fee that outweighs the benefit of the lower rate. This is particularly true of percentage-based fees that flex with the amount being borrowed. Checking the comparison rate and the proposed repayments will help.
Ongoing or Monthly fees
Also known as account keeping fees or loan management fees, these are fees that are paid every month across the life of the loan. But it’s money that goes straight to the lender without reducing the amount you owe.
For example, a $10 monthly fee on a 5-year loan adds up to $600 in ongoing fees across the life of the loan. That’s a lot of money that’s not going towards repaying your loan principal. Banks and larger lenders often have lower upfront fees that are offset with a monthly fee of $10 to $13. The net cost of the upfront fee and the monthly fee may be higher than you otherwise would have paid for a lender with a higher upfront fee and no monthly fees.
Early Repayment Fees
If you can manage it, repaying your loan as quickly as possible is a smart way to reduce the overall amount of interest you pay on your loan. However, the last thing you want is to be hit with an early repayment fee (also known as an exit fee) that undoes all your hard work. Early repayment fees are typically $150 – $175, but can range from nothing up to $800 or a percentage of the loan value on repayment. That’s a lot to pay for your own good work.
Penalty fees are just money down the drain when things don’t go quite to plan. So while you’ll probably try to avoid them, sometimes life happens and you may miss a direct debit. Be prepared by knowing exactly what the penalty fees are and make sure they’re not excessive.
The most common penalty fee for personal loans is the ‘default’, late or missed payment fee, typically because you don’t have enough money in your nominated account on the day a payment is due. Late payment fees range from $20 to $35, however, some lenders will waive the fee if the account is brought up to date within 3 days.
To help avoid penalty fees, make a budget of your expenses before you agree to the loan so you know you can comfortably make repayments. Splitting your money can also help – open a separate savings account from your daily transaction account and transfer money into it each payday to make sure you always have enough available to cover your repayments.
When it comes to fees, it’s a case of buyer beware. While you’re unlikely to be able to avoid them altogether, you can look to minimise your costs as much as possible. When you’re deciding on the best personal loan for you, always take the time to read the loan terms and conditions and look out for any other hidden fees. You might be surprised at what you find, including small things like a charge to receive paper statements. Do the maths and carefully compare all rates and fees.
4. Flexibility of Loan Length
Debt consolidation loans can be for different lengths of time. You can expect a loan term of between 2 and 5 years, but they can sometimes be up to 7 years. A longer loan term can help you be approved sooner, as the monthly repayments are lower. A shorter loan term will cost you less in the longer term, with less interest paid.
But it’s good to know loans aren’t necessarily set in stone. Look to see what flexibility there is to change your loan term, either shorter or longer, and what fees may apply.
5. Customer Service and Responsiveness
Lastly, the best debt consolidation loans aren’t just about what’s written down in black and white. Choosing a debt consolidation loan provider with a good reputation for customer service can make a big difference to your overall satisfaction with your loan. Whether you need a loan application approved quickly or just a little extra help to complete your application, you need the support of a friendly, helpful and responsive team.
Check a lender’s ratings or recommendations on review sites to see what their customers are saying about their service.
Need help finding the best debt consolidation loan for you? Whether you need a loan rate comparison or want to learn more about what’s possible for you, our friendly team is here to help. Get in touch today.