What is debt consolidation, and how do you do it?

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debt consolidation
Financial Advisory
By
John Liston
John Liston
Director | Adviser
August 25, 2021
5
minute read

A guide to managing your debts safely, smartly, and effectively

Debt consolidation can be an effective strategy for those juggling multiple debts. However, it needs to be undertaken the right way, otherwise you run the risk of accruing more debt.

In this article we’ll look at the benefits of debt consolidation, how it works, and some of the potential pitfalls to avoid when considering this option.

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What is debt consolidation?

combine existing debts into one

Debt consolidation is the act of combining all your existing debts into one. But while you can’t simply merge them together into one new debt, the way to do it is, in effect, just as straightforward.

Consolidating your debts essentially means you take out a new loan to pay out all your more expensive loans.

So for example, you may have $100k in debt across two credit cards, a personal loan, and a car loan. The interest rate may be around 15% for credit cards and personal loans, and 9% for the car loan. Along with the interest rates, each of these different debts and loans will also have different repayment periods and due dates. This means that you’re getting charged interest at different times, in different amounts.

This isn’t just confusing—it also works to erode your ability to actively pay off your debts at all.

By taking out a new loan, you’re then able to pay off your existing debts, and roll all your debt into one. By choosing a loan that has a better interest rate, you’re able to reduce the amount of interest you pay, thereby reducing the time it takes to pay off your loan.

You’re not debt-free yet, but it’s a smart strategy to get you on the way there.

Why consolidate your debts?

We don’t really need to say this, but having multiple debts hanging over your head is a bad thing. It doesn’t just take control of your money, it also can impact your mental health, causing stress to you and your family.

Consolidating your debts allows you to:

  • Have one single repayment that’s taken out of your account at one specific time;
  • Save money on interest by choosing a new loan with a better interest rate;
  • Assume greater control of your cash flow; and
  • Gain a better view of when you will be able to eliminate debt altogether.

How to consolidate your debt

There are multiple ways to consolidate debt.

Larger debts

For larger debts, you can consolidate everything into your mortgage.

This is known as a home loan top-up. You’re able to take out extra money on your home loan, and use this to pay off your existing debts. The outstanding debt amounts are then added to your mortgage.

This allows you to eliminate the extra effort of managing multiple loans and interest rates, abd instead allowing you to focus on one simple repayment, regularly, at a standard interest rate. And, as this is your home loan, it’s likely this new interest rate will be considerably lower than your other debts. For example, you may be paying a 2.99% interest rate on your home loan, compared to the 16.99% on your credit card.

The only downside to this is that it will increase your loan repayment timeframes, and your repayment amount. But it also gives you better peace of mind, with one single debt to focus on. It also enables you to take advantage of strategies to pay down your mortgage faster.

Smaller debts

If you’re after an option that’s cheaper over the short term, you may consider consolidating your debts under a personal loan.

This method may take some research. You’re looking for a personal loan that offers a better interest rate than your current debts or loans, without any hidden catches or conditions.

By taking out a personal loan in this manner, you’ll be able to save money on your interest, while combining your payments into one regular fee. This makes it easier to calculate your repayment figure and timeline.

Managing credit card debt

If it’s purely credit card debt you’re worried about, you can look into a balance transfer option. Many credit card companies offer this. It enables you to open a new credit card, and then transfer the balance of your other credit card debts onto the new one.

You’re effectively paying off the other credit cards, and consolidating each debt onto one card. This way you only have one monthly repayment to worry about.

The good news is that many credit card companies offer low or 0% interest rates on your new balance, for a select period of time. This enables you to get ahead of your repayments, and reduce the future interest you’re likely to pay. However this typically only lasts for a set period of time, and once completed the credit card reverts to a higher rate.

So this option is only recommended if you know you can pay the debt off within the set timeframe.

What to be mindful of when undertaking debt consolidation

consolidate debts

While consolidating debt can be a smart option for taking control of your finances, it’s important that you undertake it in a responsible manner. If you’re not sure about the best route to take, or which loan is right for your situation, then accessing the support of a trusted adviser is crucial.

Unfortunately, there are companies out there whose promises are as big as their terms & conditions are confusing. Their consolidation loans may sound too good to be true — in which case, they are.

To begin with, make sure to work with a provider who is licensed to enable your debt consolidation. Avoid companies that make unrealistic promises, or avoid discussing certain aspects of your debt consolidation.

It’s also wise to get everything in writing, to ensure you can confirm what you’re undertaking at the outset.

You want to be certain that in consolidating your debts, you’re not putting yourself in more debt.

If you choose to undertake debt consolidation by yourself, it’s crucial to ensure you make the right calculations. Your goal is to be paying less in interest, not more. Be sure to check for other fees and hidden costs that may drive up the price. These add up, and can result in you ultimately paying more money to pay off the one debt.

It’s always wise to double- and triple-check your calculations, when making financial investments of this manner. if a new loan is more expensive than the loan you currently have, it’s not a wise investment.

How Liston Newton can help you consolidate your debt

Liston Newton Advisory can help you determine the best strategies to manage your debt.

We can work with you to:

  • Review all your debts;
  • Understand what options are available to you;
  • Create a budget, and understand what you can afford to borrow;
  • Select the most suitable loan for your situation and goals; and
  • Organise the loan for you, right through to settlement.

It’s all about understanding your debt, understanding the implications of all options, and helping you plan the best way forward.

The final word

Debt consolidation can be a smart strategy to manage multiple debts. It allows you to:

  • Condense all your debt into one package;
  • Take advantage of a single, better interest rate;
  • Focus on one regular payment, rather than multiple different payments; and
  • Take comfort that you can see a clear path forward.

When undertaken in the right manner, debt consolidation is a tool that can help you achieve financial freedom sooner.

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