The act of consolidating debt is essentially combining several loans into one. These loans might be car loans, personal loans, even credit cards, to name a few examples.
The primary reasons to consolidate debt are to…
- Reduce the cost of the loan (i.e. interest rate and fees)
- Speed up repayment of the debt
- Simplify payments and administration
- Extending the term of a loan
Most car loans or personal loans are set up with 4- to 5-year terms, meaning that you will generally have paid the loan off (or down to a reasonable residual amount) by the end of that timeframe. Repayments over these terms therefore tend to be fairly high, in order to pay the debt down quickly. If instead you consolidate that debt into a home loan, it is then usually converted to a 30-year term (or similar), meaning it will take you 30 years to pay off that debt if you only make the minimum payments.
So, while you can save on the interest rate by consolidating debt, you need to be careful about extending the time that it takes to pay your loan off. Even at a lower rate, interest payments over 30 years are going to be much more than interest payments over 4 or 5. The easiest way to address this is to try to keep making the same repayment that you paid on the loan before you consolidated. This will ensure that you do in fact save money over 4 or 5 years by consolidating.
Some lenders will charge you exit fees to close a loan account early, and some lenders will also charge you fees to make a new application to consolidate debt. As a result, in some cases you might find that any savings in interest could be outweighed by the extra fees involved in consolidating.
Introductory rates apply mainly to credit cards. Some lenders offer credit cards at extremely attractive introductory interest rates for the first 6 to 12 months on balance transfers. These special rates usually only apply to the initial balance transfer however, and not future purchases made on that card. What’s more, when you make a repayment on the card, that money is automatically used to reduce the initial balance, not pay off your more recent purchases. You therefore need to be careful about using this type of card for both consolidation and ongoing expenses.
When you are considering debt consolidation, please contact us to discuss whether it is an appropriate solution for you. We will always ensure that debt consolidation is a positive step, not one that leaves you worse off.
Frequently asked questions