Is Debt Consolidation Right For You?

Is debt consolidation right for you? There are a few things you need to consider before opting for debt consolidation or refinancing. Tippla has provided you with an easy guide below.

What is debt consolidation?

Let’s start first with the most important question – what is debt consolidation? Put simply, it’s the process of using one loan to pay off multiple other loans. If you have more than one loan, then consolidating your debt, and rolling it into one consolidated loan, could sound like a good idea.

How does it work?

Let’s say you have three different credit cards of different amounts ($3,000, $5,000 and $8,000 for example). For each of these loans you will be paying separate interest rates, annual fees and your repayments will likely be at different times across the month.

If you want to consolidate your debt, you could instead take out a single personal loan, and use that to pay off the balance of your three credit cards, as well as outstanding interest and annual fees. Then you’ll only need to focus on repaying the single personal loan. That means you’ll only have one interest rate. 

Generally speaking, the interest rate for personal loans is lower than that of credit cards. However, with credit cards, you typically only need to pay interest if you carry over a balance at the end of the month. With personal loans, you are often paying interest each month, regardless of how much you pay. 

Different ways to consolidate debt

There are a few ways that you can consolidate your debt. Here are the three main ways:

1. You can combine all of your debt into a single personal loan;
2. If you’re wanting to consolidate your credit card debt, you can consolidate it using a balance transfer credit card;
3. If you’re wanting to consolidate your mortgage, you can do so with a home loan top-up or opt for refinancing.

Why would you consolidate your debt?

In what situation would you consolidate your debt? If you have multiple different loans or types of credit, then you might take out a debt consolidation loan to achieve the following:

1. Get a potentially lower interest rate;
2. Make your repayments easier and streamlined;
3. Have a clear timeline of when you’ll be debt-free.

Things to consider

Before taking out a debt consolidation loan, there are some things you should consider. We’ve listed the pros and cons below.

Pros

There are some pros to consolidating your debt. Here are a few:

Convenience

When you consolidate your debt, instead of having to keep track of multiple repayments, you will only need to worry about one. That means, less worry for you and less chance you might forget to repay your outstanding debt and risk harming your credit score.

Fixed rates and terms

When you take on a debt consolidation loan, you can get a loan with a fixed interest rate and term. That means you’ll know exactly how much you need to pay each month and when. This can make it much easier to budget for and could reduce the likelihood that you’d default on your loan. 

However, it is worth pointing out here, that you shouldn’t take on a loan that you can’t afford to pay. Defaulting on your loan could result in you having to pay fees and a higher interest rate, which could cost you more. Plus, defaults can harm your credit score.

Lowering your monthly repayment

If you take on a longer loan term, then your payments will be spread across a longer period and therefore, your monthly repayments should be lower. However, the longer you take to repay your loan, the more interest you’ll have to pay. This could cost you more in the long run. It’s always important to weigh the short term benefits against the long-term cost to see if you’re saving money.

Cons

Here are some of the downsides of consolidating your debt:

You might end up paying more and accumulating more debt

When you’re considering debt consolidation, you should compare the interest rate for the new loan, as well as the fees and any other costs, against your current loans or credit cards. If your new loan is going to be more expensive than your existing credit, then it might not be worthwhile to consolidate your debt. 

After all, the purpose of consolidating your debt is to try and reduce it. This is especially true if you have taken on a loan with a longer loan term, as you will likely be paying interest for the life of the loan.

It could damage your credit score

There are several ways in which taking on a debt consolidation loan could damage your credit score if you don’t use it properly. Namely, every time you apply for some kind of credit, whether it be a loan or credit card, a hard enquiry will appear on your credit report and lower your credit score, initially.

Furthermore, if you take on a debt consolidation loan and you’re not able to pay it back and you default on your repayments, then this will also hurt your credit score. That’s why it’s important to consider whether consolidating your debt is right for you.

Is debt consolidation right for you?

Unfortunately, the answer to the question “is debt consolidation right for you” completely depends on your financial situation. That’s why it’s important to weigh the pros and cons and make a decision that’s best for you.

If you’re not sure, here are some steps you can take first:

1. Reach out to a financial counsellor, they’re free, and they can provide you with advice tailored to your situation;
2. Reach out to your credit providers to see if they can change your repayments or extend your loans. The National Debt Helpline has some helpful information on how you can negotiate payment terms.
3. If you are wanting to consolidate your home loan, it could be worth chatting with your mortgage provider, especially if you are going through hardship. Alternatively, it could be beneficial to switch home loans altogether and find one with a lower interest rate and fewer fees.