Debt Consolidation with Personal Loans: A Step-by-Step Guide for Australians

What is Debt Consolidation?

Debt consolidation means rolling several debts into one new loan, after which you make one regular repayment to one lender. Instead of juggling multiple credit card bills, store cards, or other loans, you take out a single loan to pay off those debts, leaving you with one repayment to manage.

In Australia, debts that may be consolidated include credit cards, personal loans, store cards, buy now pay later plans, and car loans. This approach can simplify your finances and potentially lower your overall interest costs, but it is not the right choice for everyone.

Sources: Moneysmart (Australian Securities and Investments Commission)

How a Debt Consolidation Personal Loan Works

A debt consolidation personal loan is a type of personal loan, typically unsecured. You borrow an amount equal to the total of the debts you want to pay off, then use the loan funds to clear those balances. After that, you make regular repayments to the new lender over an agreed term.

Personal loans in Australia are typically used for specific purchases and are repaid with interest over a fixed term, usually between one and seven years. When you consolidate, the new loan term might be longer than the remaining terms of your existing debts, which can lower your regular repayments but may increase the total amount you pay over time.

Sources: Moneysmart (Australian Securities and Investments Commission)

Consolidating Debt with a Personal Loan

Debt consolidation may help if you pay less overall, have a clear end date (meaning the new loan term is not longer than your current debts), can afford the repayments, and stop using old credit.

However, debt consolidation can cost you more if the interest rate or fees are higher than before, or if the repayment term is longer, increasing the total interest paid. For example, a $20,000 debt refinanced to a lower interest rate but over a longer term can reduce weekly repayments but increase total cost: $25,496 over 5 years at 10%, $29,119 over 10 years at 8%, and $30,379 over 15 years at 6%. This shows why comparing the true long-term cost is essential.

Another significant risk is that turning unsecured debts into a secured loan puts your home or car at risk: the lender can sell the asset if you cannot pay off the new loan.

• Potential pros: one regular repayment, possibly lower overall interest if the rate is lower and the term is not extended, and a clear end date when the loan term matches or is shorter than your current debts.
• Potential cons: higher total interest with a longer term, possible fees, and the risk of losing an asset if you use a secured loan.

Sources: Moneysmart (Australian Securities and Investments Commission)

Steps to Consolidate Your Debt

Before consolidating, work through these steps to compare your current debts with a potential new loan and check whether the change genuinely helps you.

Listing everything you owe helps you see the true cost of your current debts, including interest and fees. Comparing them with the new loan's features lets you see whether you would pay less overall or just lower your regular repayment by stretching the term.

A stress test checks whether the new repayment would still be affordable if your circumstances change. Being honest about your future credit use helps you avoid running up new debts and making the situation worse.

1. List all current debts, including the balance, interest rate, fees, remaining term, and current repayments for each.
2. Compare these details with the new loan's interest rate, all fees, loan term, repayment amount and frequency, whether the rate is fixed or variable, and whether extra repayments are allowed without penalty.
3. Stress-test your budget to see if you can afford the new repayment if interest rates rise, your income drops, or living costs go up.
4. Ask yourself honestly whether you will cancel old credit cards and other debts and avoid applying for other credit before consolidating.

Sources: Moneysmart (Australian Securities and Investments Commission)

Factors to Consider Before Consolidating

Before you decide to consolidate, weigh the potential benefits against the risks. Debt consolidation may help if you pay less overall, have a clear end date, can afford the repayments, and stop using old credit. If you do not meet these conditions, consolidation can make your situation worse, particularly if you cannot afford the new repayments.

Be cautious of switching to a loan with a longer term: the interest rate may be lower, but you could pay more in interest and fees in the long run. Always compare the total cost over the life of the loan, not just the regular repayment amount.

Sources: Moneysmart (Australian Securities and Investments Commission)

How to Avoid Debt Consolidation Pitfalls

Some companies advertise that they can get you out of debt no matter how much you owe; this may be unrealistic. You should avoid companies that are not licensed, ask you to sign blank documents, refuse to discuss repayments, rush the transaction, or won't put all costs in writing.

If you have trouble paying debts, you may benefit from talking to a free financial counsellor via the National Debt Helpline on 1800 007 007. They can provide independent advice tailored to your situation.

Sources: Moneysmart (Australian Securities and Investments Commission)

Alternatives to Debt Consolidation Loans

Consolidation is not the only way to manage multiple debts. An alternative is to tackle debts one by one: pay the minimum on all debts and put any extra money toward the debt with the highest costs, such as the highest fees and interest rate. This approach can save money on interest and help you become debt-free without taking on a new loan.

Shopping around for a personal loan can also save money, as a lower rate or fewer fees can save thousands over the life of the loan. If you decide consolidation is right for you, comparing offers is a key step.

Sources: Moneysmart (Australian Securities and Investments Commission)