A debt consolidation loan is a personal loan you take out to repay a number of smaller loans (such as unsecured loans, credit cards, store cards etc.)
There are a number of ways a debt consolidation loan can help. Below we explain exactly what the benefits are plus what you need to know before you apply for one.
A debt consolidation loan will generally reduce the monthly repayment amount compared to what you are currently paying. This is the major benefit of a debt consolidation loan, as it is designed to improve your cash flow.
It would be an unlikely choice to take out a debt consolidation loan if the monthly repayments end up costing you more than what you’re paying now.
However, this would make sense if you can financially afford to do so, and you have a set priority to clear all of your small debts once and for all. For example, if you are planning to buy a house very soon and want to clear all of your small debts before you apply for your mortgage. We discuss this in more detail later.
With a debt consolidation loan, you will have one new repayment to focus on, rather than a number of them. This will make it much easier for you to budget, as you won’t have to make separate repayments on different days to different lenders.
Even though you may have direct debits in place, having the money in your account to cover the numerous payments when they are due can be tricky.
Ultimately if one of your direct debits doesn’t go through, you then can be up for late payment fees and possible penalty interest so by having just one repayment to come out should make it much easier to manage your finances.
This goes hand in hand with easier to manage. By having a number of smaller loans that have different repayment due dates, it can mean it’s potentially more likely you can get caught out without enough money to cover the repayments throughout the entire month.
Not only does this mean you could be charged dishonour fees and penalty interest, but it affects your credit rating which will impact how lenders look at you when you apply for another loan in the future.
Often the first step towards getting your first home is to start saving. Generally most people have a number of small debts they have built up over the years, so many brokers recommend you roll all your debts into a debt consolidation loan so you can then focus on your savings plan.
These days you generally require a minimum of 5% savings to buy a home, and on a $400,000 purchase price that means $20,000. A debt consolidation loan can help get you on track with a savings plan so you can make your home ownership dream a reality.
There is no point taking out a debt consolidation loan to get back on track, if you then go and take out more debts.
Make sure you are committed to repaying and closing the debt consolidation loan, so that you don’t get caught in a vicious cycle of debt.
Often the debt consolidation loan may be over a longer term than one or more of the debts you wish to pay out. For example, you may only have 18 months remaining on a loan, but your debt consolidation loan could be structured over 2 years.
This may be absolutely necessary for you so the repayments became more manageable, but it’s important you do understand that in some cases you may compromise the loan term of some of your debts to get you back on track.
It’s not a guarantee that you are eligible for a debt consolidation loan. Unfortunately some people do get into a position where they can’t afford all of their debts, so a lender may not be able to approve a debt consolidation loan.
In these situations it may be necessary to sell something to reduce the total loan you require, or speak to financial counsellor (the Government provides a free financial counsellor service by calling 1800 007 007.)
If you are declined a debt consolidation loan try to acknowledge the position you have got into and ask the lender if they could give you an idea of when you may be eligible. It may be a matter of waiting 3 or 6 months before you can be considered, so armed with that knowledge work hard to reduce your debts (and don’t take out any others) and before long you can get back on track.
Before you payout any existing loans, just make sure you are aware of all the costs and fees you may be up for.
Sometimes you could be up for early payout fees or penalty interest so it’s important you ask the lenders about their fees etc before you proceed to pay it out.
Because debt consolidation loans tend to be larger sized loan (as they consolidate a number of smaller loans together) you will be more likely to be eligible for a debt consolidation loan by having the following attributes:
It’s important to understand that there is a distinct difference between a debt consolidation loan provided by a personal loan lender, and a debt consolidation service provided by a debt management provider.
In simple terms, a debt consolidation loan helps you roll your existing small loans into one, achieving you the benefits outlined earlier. These loans operate just like other loans, generally charging interest and fees, and are provided by a lending institution who you deal directly with.
Debt consolidation loans should not affect your ability to borrow in the future, as long as you repay your loan on time.
Alternatively, in the unfortunate event you can’t manage numerous loans, a debt management provider may suggest they assist you with a debt consolidation solution.
Debt management providers often use of the term “debt consolidation” too, but in this case it involves legal agreements such as part 9 debt agreements, informal debt agreements and even declaring bankruptcy, all of which will affect your ability to borrow in the future.
We hope this has helped explain what debt consolidation loans are, what the benefits are, who they best serve and what you should know before applying for one.
If you’d like to read more information about debt consolidation loans, you’re welcome to read another of our blogs, “What does a debt consolidation loan look like?” which shows you some examples using figures to help clarify how debt consolidation loans really can help.
If you have any further queries, please know our Customer Service Team are happy to answer your questions and can be contacted on 1300 324 746.