Consolidating Debts: How does it work?

How does debt consolidation work?

You can choose to apply for a debt consolidation loan through one of your current lenders or you may decide to find a new one. No matter which route you choose, you’ll need to apply for a new loan and provide proof of income and other details, including (but not limited to) identity details.

In addition, as part of the application process, you will need to specify which debts (including credit cards, personal loans, and car loans) you would like to consolidate. You may also choose to leave a few open and pay them yourself as normal. If you're approved for the loan, the lender will use the loan amount to pay off your chosen debts. This means you'll only have to make one monthly payment to the lender, rather than multiple payments to different lenders or creditors.

Some lenders may set or recommend a specific loan term, or some may allow you to choose this yourself. Just keep in mind that while a longer repayment period may bring down your regular repayment amount, it can also increase the amount of interest you’ll pay overall so try and find the balance that’s right for you.

Secured or unsecured?

There are two main types of debt consolidation loans in Australia: secured and unsecured.

Secured loans mean you offer up collateral, such as a car or a property, which the lender can repossess if you fail to make your payments or default on your loan. These loans generally have lower interest rates than unsecured loans.

Unsecured loans don't require collateral, but they usually have higher interest rates than interest rates of secured loans to compensate for the added risk to the lender. They can be a good option if you don't want to put your assets at risk or if you don’t currently have anything to use as security.

Benefits of debt consolidation loans

Debt consolidation loans can be a great way to manage debts as they may allow you to:

• Simplify your finances: By consolidating all your debts into one loan, you'll only have to make one monthly payment, which typically makes it easier to manage your finances.
• Lower interest rates: Debt consolidation loans can offer lower interest rates than your existing loans, which save you money over the life of the loan.
• Longer repayment periods: Debt consolidation loans often have longer repayment periods than credit cards or personal loans, which can make your monthly payments more affordable.
  

Fees

As with any loan, debt consolidation loans will come with fees and charges, including (but not limited to) establishment fees, account-keeping fees, and early exit fees. These will be clear in the application process and will also be laid out in your loan contract, so there won’t be any surprises later.

If things don’t quite go to plan and you miss a repayment or don’t have the full repayment amount available in your bank account, you can expect your lender to charge a missed or late payment fee. This is usually added to the next payment amount but will vary between lenders.

Rates

While debt consolidation loans may generally usually offer lower interest rates than your existing debts, you'll need to consider the interest rate on the new loan and the repayment period to make sure you're not paying more interest overall.

With rates on the rise, a fixed or variable rate can make a big difference to the total cost of a loan. A fixed rate means the rate is locked in for the life of the loan - it may be a bit higher but it means you won’t be affected by rising rates and your repayment amount will stay the same across the life of the loan. A variable rate might be lower initially but it could leave you open to significant rate increases which can add up quickly.

But remember, the lowest rate isn’t always the best or cheapest option and you’ll need to look at the whole picture to find the best loan for you. A comparison rate is a great way to compare and choose between lenders as it takes interest and fees into account.

Repayment amount and schedule

Debt consolidation loans can help relieve financial stress, so make sure the new repayment amount and repayment schedule fit comfortably into your budget. Some lenders may also allow you to customise your repayment date so you can line it up with your pay cycle to make things even easier.