If you’re struggling with debt at the moment, you’re not alone. A recent survey by News.com.au found 30 percent of Australians are in debt and fear they may carry that debt for the rest of their lives. A staggering 91 percent of respondents have credit card debt, and just 38 percent have more than $5,000 in savings.1 Many people who are struggling with high-interest debts look to debt consolidation as a way of making their situation more manageable. However, if they fail to address the reasons they ran up the initial debt in the first place, debt consolidation could open the door for them to run up more debts and be worse off than they were when they started. You can start an online search to learn more about debt consolidation options.
What Is a Debt Consolidation Loan?
A debt consolidation loan is a financial tool that can help some people get out of debt by allowing them to lower their monthly payments and, as the name suggests, consolidate multiple debts into one single payment. A person with several high-interest credit card debts or short-term loans could take out a loan at a much lower interest rate and use that loan to pay off the cards. This can save them money over the long term and reduce their monthly outgoings in the short term. When used properly, consolidation loans are a lifeline for borrowers, helping them get a difficult financial situation under control.
Why Do People Choose Debt Consolidation Loans?
Debt consolidation can be appealing for people who are carrying large balances on credit cards. The average credit card interest rate in Australia is 19.94 percent, so clearing a credit card can feel like an impossible task.2 Payday loans carry even higher interest rates, and many families end up trapped in a cycle of borrowing every month because they’re struggling to meet the interest payments.
Debt consolidation offers an opportunity for people who are faced with crippling interest rates or high monthly repayments a chance to take some of the pressure off their wallets, so they can focus on paying down their debts.
The Benefits of Debt Consolidation Loans
When used as intended, by someone who budgets effectively in the future, debt consolidation can have many benefits:
- Debt is rolled into one loan and one monthly payment instead of multiple
- Easier to make payments on time
- Monthly loan payment never changes
- Can carry a lower interest rate
Debt consolidation loans can be found with interest rates of as low as 5.45 percent almost one-quarter of the rate of the average credit card. This means a greater percentage of the monthly payment goes to reducing the debt, which helps pay off the debt more quickly.
Common Debt Consolidation Pitfalls
There are some common pitfalls associated with debt consolidation loans, especially if people use them as a quick fix. Some common issues are:
- Some debt consolidation loans require collateral, such as your home or vehicle
- Those with bad financial habits can spiral, or take on more debt because they feel they’ve reduced their debts
- Requires a hard inquiry on your credit report, which can temporarily lower your credit score
- Debt consolidation loans can include fees
Debt consolidation loans don’t address the underlying reason why the person got into debt in the first place. If they don’t start budgeting carefully and keep their habits in check, they could end up owing even more money in the long run.
Debt Consolidation vs. Balance Transfers
One alternative to debt consolidation is a balance transfer credit card. These cards can be a good option for some borrowers, but they come with their own pitfalls. There’s often a fee for the incoming transfer, and while many card issuers offer an introductory rate (often of zero percent), once that introductory period expires the interest that’s applied can be very high.
For this reason, it’s only worth taking out a balance transfer card if you know you can clear the amount you transfer before the introductory period comes to an end. If you have a lot of debts or debts that don’t qualify for a balance transfer, debt consolidation may make more sense.
How to Choose a Debt Consolidation Loan
If you’ve decided you’d like to take out a debt consolidation loan, the next step is to find a favorable rate. One option is to use an Australian debt relief program that offers a free debt analysis. Experts will look at your financial circumstances and work out whether you qualify for assistance. This can be done without a hard credit check, meaning it won’t impact your credit score.
If you do need to consolidate your debts, you may be able to get a consolidation loan of up to $75,000 secured, and interest rates can be as low as 5.45 percent p.a. If you’re looking for an unsecured loan, you may find the amount lenders are willing to allow you to borrow is lower, but you should still be able to get an interest rate that beats your existing credit cards.
Average Debt Consolidation Interest Rates
The interest rate of a debt consolidation loan will vary. Lenders consider your credit score and the term of the loan when setting interest rates. Someone with an excellent credit rating may be able to get an unsecured debt consolidation loan with a rate of between 5.45 and 8.48 percent from a mainstream lender, such as OMM.3 Someone with a poorer credit history may only be offered unsecured loans closer to 20 percent p.a., however. Secured loans usually offer more favorable rates but should not be entered into lightly.
Fix Your Spending Habits Before You Borrow More
Before you take out a debt consolidation loan, work out your monthly outgoings and make sure you’ll be able to afford the loan repayments. Cancel the credit cards after paying them off, so you can’t run up new balances on them. Think about why you ended up in debt. If you were living beyond your means, make changes to your lifestyle, so you don’t end up in debt again. Use the consolidation loan as a chance for a fresh start.
Alternatives to Debt Consolidation
If you’ve already missed some payments or your credit history is poor and you don’t qualify for a debt consolidation loan, look at other ways of paying back your debts. One option is to use the snowball method, paying off the highest interest rate debts first. Some people adjust this method and pay off the smallest debts first to get the psychological benefit of having fewer outstanding debts.
Each time a debt is cleared, the money that was servicing that debt gets added to the payments on the next-largest debt. Using this method, you can clear your outstanding debts quite quickly.
Be Wary of Secured Loans
Some debt consolidation loans are secured on an asset, such as your house or your car. Lenders are usually willing to offer larger loans and lower interest rates for secured debts. However, if you become unable to make repayments on those debts, you may be at risk of having your home or car repossessed. Don’t enter into this kind of loan unless you’re fully aware of the risks and confident you’ll be able to make the repayments on time every month. Secured debt consolidation loans should be seen as a last resort.
Talk to Your Lenders if You’re Struggling to Make Payments
It’s easy to feel overwhelmed when you’re struggling to make repayments on your debts. Most lenders are happy to work with people who are struggling if they take the time to communicate with them.
Make sure your priority debts, such as taxes, utility bills and rent or mortgage payments, are serviced before worrying about other debts. Contact lenders and ask them for a hardship variation. Your credit score may suffer in the short term from doing this, but over time, as you make payments and clear your debts, your score will repair itself.
Get Help to Get Out of Debt
Help is available for people who are struggling with debts. The Moneysmart website provides a wealth of information for people who are in debt and considering taking out a consolidation loan or looking at other options for dealing with their creditors.4 If you’d prefer to speak to someone on the telephone, call the National Debt Helpline on 1800 007 007 for free, confidential advice about personal finance and debts.5
It’s important to address financial issues early. The sooner you seek advice, the more likely it is you’ll be able to come to an arrangement with creditors. Talking to someone about your debts quickly can help reduce the late fees and interest you pay, making it easier to address the problem.