Having trouble keeping up with different loans? Sometimes debt can have a way of spiralling a bit out of control, making it difficult to keep track of which loans should be paid off first.

It might be worth rolling all your debts into one. Debt consolidation is when you take out one loan to pay off other loans. You can combine high-interest car payments, hire purchase loans, buy now pay later debt and credit card payments all into one easy-to-manage loan.

How can consolidating debt help you?

One loan at a fixed, lower interest rate makes the regular repayments easier and more affordable. It can simplify life by reducing stress and making budgeting easier. Also, because you’ll be paying less in interest, you can save money which you can then use to pay your debt off faster.

How does debt consolidation work?

You can apply for a loan or line of credit from a bank or second-tier lender to pay off multiple debts that have high-interest rates. If you are a homeowner, a debt consolidation loan can be taken out on a mortgage. Banks will lend up to 80% of the value of your home.

A consolidation loan may help you get out of debt if:

  • it has a lower interest rate than the debts you are putting together
  • you pay a lower monthly payment than all your other debts put together and you put the extra money toward paying down your debt faster
  • the goal is to make a change in spending habits, and you don’t create more debt by spending the available credit you free up.

Is debt consolidation a smart move?

When it comes to debt consolidation loans, there are four key things you need to focus on:

  • interest rates
  • debt type
  • repayment terms
  • fees

Consolidating debt can be a great idea, but only works if you do it right.

Interest rates

A debt consolidation loan is only a good move if the interest rate on the new personal loan is lower than the interest rates on all your existing debts. Do your maths to see what your current interest rates are and compare that to the personal loan interest rates you’re being offered.

Types of debt

It is not the best method for all types of debt. To understand whether debt consolidation is the right choice for you, the first step is to calculate the total amount of debt you can combine, and which will be the best debt to consolidate. For example, if you have a student loan that is currently not fully interest-bearing, it is not a good deal to incorporate that into your debt consolidation loan.

Time frames for repayment

You need to be very aware of the time frame for your new loan. If you’re paying off car payments, personal loans, hire purchase loans, buy now pay later debt and credit card payments all at one lower rate but over a longer period, that may end up costing you more.

If you’re a homeowner with a number of high-interest loans, like a car loan, hire purchase debts or credit card debt, you could pay those off by increasing your mortgage. However, to make that work, you’d need to increase your regular repayments so that the date you finally mortgage pay your off remains the same, otherwise, the loan is being paid off over a longer period and the total you pay back will be higher. In fact, the best way to go about it, if you can, is to make the new mortgage repayments the same as the total repayments for all your loans put together. But because mortgage interest rates will be lower, you’ll be able to pay the total debt off more quickly.

Fees and costs of debt consolidation

There are fees involved with setting up a consolidation loan, such as

  • Discharge fees: when you repay your debt from your new loan, the debt company you owe money to may charge an additional discharge or early repayment fee.
  • Set up fees: check the contract and the fine print for costs involved in setting up a loan. Are there fixed fees and how much are they?
  • Valuation fees: if you’re a homeowner, you may need to get your house valued to see how much you can borrow and what debt you can consolidate.
  • Solicitor fees: if you’re taking out a new home loan, banks may involve a solicitor who will charge you a fee.

When does consolidating debt stop making sense?

Debt consolidation might not be helpful:

  • if it costs more in interest in the long run
  • if you only have only a small amount of debt that can be paid off in a short amount of time
  • if you’re not committed to staying out of debt and spending more after paying off the debt.

Are you a good candidate?

To get a debt consolidation loan, banks or second-tier lenders will want to know why you are consolidating, and they’ll want to know about your ability to pay off your new loan, and your ability to provide security. Before discussing a consolidation loan with a lender, you’ll need to have records detailing your credit history, savings and debt repayment history and your income: your ability to service debt.

Paying back a consolidation loan

The purpose of a consolidation loan is to get yourself out of debt. Making the minimum payments on your loan will normally only cover the interest that you owe. You won’t get out of debt if you only pay this amount. Increase your payments to as much as you can so you’ll reduce your debt faster and pay less in interest.

Stay on track to a brighter financial future

The goal is to save money in the long term, not to spend more. It may be tempting to relax after consolidating all your debts, but it’s important to remember how you got debt-burdened in the first place. To avoid future financial trouble, it is a great idea to get in the habit of tracking your spending to see where your money is going and putting a stop to any bad habits before they creep in.

It may also be an idea to speak to a financial or budgeting expert before you make any future big-spending decisions. They’ll be able to tell you how to best manage your money, so you don’t end up in more debt.

Financially better future

If you want to start looking forward to a more stress-free future, cleaning up your finances through debt consolidation is a good way to begin. When you’re shopping around for a loan provider, be sure to look for one that offers flexibility, individual customer service, quick turnaround times and tailor-made solutions to suit. This is really important in case your circumstances change, for whatever reasons, and you’re unable to maintain the level of repayments.

Make sure you find out the total cost of consolidating, including the set-up fees before signing up. Some lenders may incorporate their rates and fees into your weekly payments and not be clear about how long you have to repay the loan and what their charges are. Choosing the right lender will make all the difference. Shopping around, comparing the available rates and reading all the fine print truly helps

For information on independent confidential budgeting services or advice, visit www.moneytalks.co.nz.