The Pros And Cons Of Debt Consolidation

If stress about the rising cost of living is making you consider your options, debt consolidation may be on your radar. But before you take the leap – and potentially end up with more debt than you have now – it’s important to understand the pros and cons of debt consolidation to decide if it’s the best choice for you.

What is debt consolidation?

Debt consolidation is when you take out one bigger loan to repay a collection of smaller ones. It’s different from refinancing, which is where you replace or extend an existing loan with funds from the same lender, or a different one who can offer you a better rate.

If you’re facing a range of repayments on different dates that are making it hard for you to budget, debt consolidation may make it easier to manage. But, if the interest rate on the new loan is higher than the individual loans you had previously, you may pay a hefty price for the pursuit of one neat repayment date.

Is debt consolidation right for you? Here are some pros and cons

The pros of debt consolidation

a lower fortnightly or monthly or fortnightly payment may help you budget better
all your debts in one place means fewer repayments to stress over
potential to save money by combining higher interest rate loans
stretching the life of your debt may mean smaller repayments each month to give you some cashflow relief

The cons of debt consolidation

by giving just one lone creditor all your debt, they wield a lot of power over you – and that may make negotiations over missed repayments and extensions you may need challenging. If consolidating your debts means it costs you more because the life of the loan is longer, it may be a false economy, depending on your circumstances
costs around setting up a new loan and exiting old ones can add up
if your debt consolidation rolls old debt into your mortgage, be aware that any co-borrower attached to your home loan is now taking on your old debts
there may be penalties or fees associated with paying out other debts.

Things to check before agreeing to debt consolidation

Is the new offer from a lender that is Australian Securities and Investments Commission (ASIC)-registered and licensed?
Will the interest rate on offer for one debt consolidation loan add up to less than your combined loans?
How much are the fees and charges?
How will your budget benefit?
Do you have other options?
Are you putting your home or other significant assets at risk?
Will anyone else be affected?
What steps are you taking to avoid adding further debt?

Speaking to a financial counsellor before you sign on the dotted line is highly recommended.

An example of positive debt consolidation

Debt consolidation can be an easy three-step process that is as simple as:

taking out a new loan
using the new loan to clear old debts
paying off the new loan.

When it works well, the benefits are measurable, as Think Advantage mortgage broker Natalie Wilcox reveals with an example of a recent client’s debt consolidation that created significant savings:

client owed $173,000 on mortgage with repayments of $1538 @ over 7.75%
credit cards $33,000 with monthly repayments of $1050
total monthly outgoings = $2588
refinanced all debt, kept loan term – total loan $206000 – new interest rate 5.29% = $1533/month repayment
client $1055/month better off and no credit cards at all.

The bottom line

Is debt consolidation a good idea? For borrowers who have several high-interest loans, potentially, yes! But looking to debt consolidation as a magic fix is never a good idea unless you tackle the issues that are causing your debt issues in the first place. Although it might seem like a good idea to pay off all those credit cards you’ve built up with one neat debt consolidation loan, using the debt payment as an opportunity to go out and rack up more credit card debt will land you in a worse financial position than before.

Go deeper: Debt consolidation and refinancing

Financial disclaimer

The information contained on this web page is of general nature only and has been prepared without taking into consideration your objectives, needs and financial situation. You should check with a financial professional before making any decisions. Any opinions expressed within an article are those of the author and do not specifically reflect the views of Compare Club Australia Pty Ltd.