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What is a debt consolidation personal loan?

Paying off multiple debts at once might feel overwhelming at times, but a debt consolidation personal loan could make it a little easier by streamlining your repayments, simplifying your budgeting and potentially even saving you money.

A debt consolidation loan is a type of personal loan that allows a borrower to roll multiple credit products, like an existing personal loan, car loan, and maybe a credit card or two, into one. The borrower would then begin to make singular monthly repayments on the new loan, paying down their existing debt in a more manageable way.

How might a debt consolidation loan help?

A debt consolidation loan might be able to help you get your financial situation back on track in more ways than one. Depending on your personal circumstances, some of the benefits this kind of loan may offer include the following:

  • You'll only have one regular repayment to keep track of. This can make budgeting and paying your bills more manageable, ease any stress on your bank account, and reduce your chances of missing payments.
  • By rolling your various loans and/or credit card debts into a single account, you'll only have one set of fees to pay instead of multiple.
  • If your debt consolidation loan has a lower rate than your previous financial products, you could reduce the amount you pay in interest charges.
  • Consolidating your debt could help you boost your credit score in the long run, by providing you with the opportunity to demonstrate positive credit behaviours.

Are there any risks with debt consolidation personal loans?

Just like most financial decisions, there are some risks that are important to consider before applying for a debt consolidation personal loan, including the following:

  • If you have a less than desirable credit history, you could find it difficult to get approval for a debt consolidation loan. Or, you may only be approved for a loan with a high interest rate.
  • If the debt consolidation loan has a longer loan term than your existing loans, it could end up costing you more. This is because paying a debt over a longer period of time can mean paying more in interest, and in turn a higher total cost of the loan.
  • If you get access to more credit with your consolidated loan, you could end up spending and owing more throughout the life of the loan. So, it's important to ensure your debt consolidation loan covers your existing debts only.
  • It may not be the cheapest option available. Consider what other options you may have, such as a balance transfer credit card, to determine which could save you the most.

Can a debt consolidation loan affect your credit score?

Financial products of all kinds will generally have an effect on your credit score, and debt consolidation loans are no different. But, understanding the ways in which your credit score could be affected can help you protect your credit file and work towards increasing your score.

How it could hurt your credit score

When you first apply for a debt consolidation loan, the credit provider will perform a hard enquiry on your file before your application is approved. If you have other recent enquiries on your file, then there's a chance your credit score could take a hit

However, if the new loan allows you to get on top of your debts and into a better financial position, it's likely the benefits could outweigh any initial hits to your credit score in the long run.

How it could improve your credit score

If you are diligent with making your regular repayments on your new loan and consistently paying down your debt, demonstrating positive credit behaviours, there's a good chance your credit score will see an improvement. The introduction of comprehensive credit reporting means both positive and negative information is now recorded on your credit file, so an increased number of positive credit events can be beneficial to your score.

Building your credit score back up can help you down the track if you want to apply for other financial products, such as a home loan. Borrowers with good credit scores are typically offered more competitive interest rates by lenders, and have a higher chance of having a loan application approved.

What types of debt can personal loans solve?

There are a number of different kinds of personal finance debts that can be rolled into a debt consolidation personal loan. For many borrowers, it may be a combination of any of the following:

  • Credit cards - Whether you have multiple credit card balances that you want to consolidate, or a single credit card that you wish to consolidate with other types of debt, credit card debt is one of the more common forms of debt that borrowers choose to consolidate using a personal loan. It's worth noting, however, that you likely also have the option of a balance transfer if you are looking to consolidate credit card debts alone.
  • Existing personal loans - You may have one or more existing personal loans, with different loan amounts and purposes, that you would like to consolidate with other credit products by taking out a new personal loan. If this is the case, also consider whether refinancing to a low rate could also be an option.
  • Car loan - If you're finding it difficult to juggle your car loan repayments with other types of debt, a debt consolidation loan may simplify your finances and potentially lead to cost savings, depending on your personal situation. Keep in mind, however, that if your current car loan is a secured loan, it may have a more competitive interest rate than an unsecured personal loan can offer.
  • Debt collection agency debt - If you have outstanding bills or fines owed to a company or organisation, which they have made failed attempts to recover from you, they might pass them on to a debt collection agency. Some credit providers may allow you to consolidate debts held by debt collection agencies with a personal loan.

Case study: Bella rolls her debts into one

Bella has two credit cards, each with a $2000 debt owing and monthly repayments due at separate times. They both have interest rates over 20 per cent. She also has $5000 left on her car loan that she is paying off on a monthly basis with an interest rate of around 8 per cent.

She makes a total of three separate repayments each month, plus pays $250 in annual fees for the cards and car loan. While she can afford all of these repayments, Bella finds it hard to keep track of due dates (increasing her chances of a missed payment) and how much she has paid off on each credit facility. 

Bella has her sights set on a big overseas holiday, but wants to be debt-free before she starts to save. She decides that the easiest way to do this is to roll all her debts into a personal loan so she can make one monthly repayment and control the time it takes to repay the debt. She is offered a personal loan with an interest rate of around 10 per cent – half of what she’s currently paying on her credit cards. 

Once she's approved for the personal loan, Bella uses the cash to pay off the credit cards, effectively rolling them into the one loan. As her car loan doesn’t allow unlimited extra repayments, Bella has to pay a small fee to pay out the loan and roll it into her new personal loan. Bella calculates that the money she can save on annual fees and by paying her car off sooner will make this upfront cost worth it in the long run. 

Now, with all her debts rolled into one, Bella knows that she can be debt-free by this time next year, and start saving up for her dream holiday.

How do I compare debt consolidation personal loans?

As a type of personal loan, debt consolidation loans have many different features to consider. Comparing each feature carefully can assist you with finding the right product for you – because what’s best for one borrower may not be what’s best for another.

Interest rate

The interest rate will determine how much you pay in interest charges over the life of the loan. You’ll need to decide between a fixed or variable rate for your personal loan. A fixed interest rate will remain the same throughout the life of the loan, while a variable interest rate can fluctuate with the market.

Comparison rate

When comparing personal loan rates, remember that a lower interest rate won't always amount to a cheaper product, because interest rates don’t factor in fees. This is where the comparison rate comes in handy, as it includes both the interest rate and the main fees payable, which can give you a better idea of the loan’s total cost.

Secured vs unsecured

A secured personal loan is a loan that’s secured by an asset, such a car, which is used as collateral for the money borrowed. An unsecured personal loan doesn’t have an asset attached. Secured loans often have lower interest rates than unsecured loans as lenders consider them to be less of a risk. Remember to keep this in mind if you are planning to consolidate a secured car loan with other debts.

Loan term

The amount of time you have to pay off your loan is determined by the length of the loan term. Personal loans typically have one to five year terms, but some lenders offer loan terms up to seven years, and sometimes longer. Remember, when consolidating existing debts, it's important to avoid choosing a longer loan term than you already have as it could end up costing you more over the life of the loan.

Extra features

Different personal loans may offer extra features that could be important to you and how you pay off your loan. Some of these include:

  • Extra repayments – One way to pay off your personal loan sooner is to make extra repayments. But, not all lenders will allow you to make additional repayments, and some may charge a fee, while others may offer unlimited extra repayments.
  • A redraw facility – A personal loan with a redraw facility will allow you to 'redraw' extra repayments you’ve made. This can be handy if you want to pay less interest on your personal loan, but still want access to your money. Keep in mind that not all personal loans come with redraw facilities, and those that do may charge redraw fees.
  • Flexible loan repayments - Some lenders may give you the option to make weekly, fortnightly or monthly repayments.

Fees

The types of fees you may be charged for your personal loan will differ from one lender to the next. Some of these may include:

  • Loan application fees
  • Establishment fees
  • Monthly fees
  • Late payment fees
  • Extra repayment fees
  • Early repayment fees/exit fees
  • Redraw fees

How do I find the best debt consolidation personal loan?

To make your debt consolidation personal loan comparison more simple, RateCity has a number of tools that may be useful to you.

Personal loan comparison table

RateCity's comparison tables, like the one on this page, can be a helpful tool when narrowing down your personal loan options. You can search by loan amount and loan term and use the filters to find products that may be more suited to your needs.

Personal loan calculator

RateCity’s personal loan calculator can give you an estimate of your repayment amounts based on the amount you’d like to borrow, your preferred loan term and interest rate. It can also provide you with an estimate of the total interest payable and total amount payable.

Real Time Ratings

Real Time Ratings is a system that ranks personal loans based on your own individual requirements. It gives each personal loan a score out of five stars, based on loan costs and flexibility, in real time as you use the site.

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Tips to avoid adding to existing debt

  • Don't be tempted to apply for a personal loan with a borrow amount that's more than your existing debt. The purpose of a debt consolidation personal loan is to consolidate and get on top of existing debt, not to add more.
  • Avoid continuing to use your credit card after you have paid if off. Doing so will mean not only having to cover your new debt consolidation personal loan repayments, but additional credit card bills as well.
  • Consider any break fees and/or establishment fees you may be liable for when consolidating your debts. If these costs add a substantial amount to your existing debt, it may be worth paying down your individual debts rather than consolidating. Be sure to make comprehensive calculations before deciding on what's right for you.

What other options are available as an alternative to debt consolidation in Australia?

A debt consolidation personal loan can be a helpful tool for some, but there are other options that may be worth exploring. Some of these include:

  • A balance transfer credit card - A balance transfer involves moving a debt from your existing card provider to a new balance transfer credit card that charges you zero per cent interest on your transferred balance. Keep in mind the zero per cent interest offer is usually only for a limited time before it reverts to an often higher than average interest rate.
  • Refinance - You may be aware that you can refinance a home loan, but did you know you can also refinance a car loan or a personal loan? If you're unhappy with the interest rates, fees or features your current loan offers, you could consider refinancing to a more competitive loan product in order to save money. Just be sure to check the lending criteria before you begin the application process to ensure you are eligible for the loan you are interested in, and factor in any early exit fees and the like when doing your calculations.
  • Talk to your credit provider - Consider reaching out to your credit provider to see if you can negotiate a longer loan term, or a more or less frequent payment schedule, in order to potentially make your repayments more manageable.
  • Ask for help - Remember that you can access free financial counselling and advice if you are experiencing financial stress. The National Debt Helpline can help you get your finances back on track, and the National Association of Community Legal Centres are not-for-profit, community-based organisations providing free legal help to those who need it most.

Can I merge my personal loan with my home loan?

Yes, you can refinance your home loan and, in the process, merge or consolidate your personal loan and home loan. By doing so, you can lower the number of debts you have, and you may also reduce the total interest you have to pay.

However, you should consult a financial advisor or a mortgage broker to confirm that you are decreasing your total outstanding debt, including interest payments. The repayment term for a home loan can be much longer than that for a personal loan, and by merging the two, you could be repaying a higher amount over the full term.

What are the pros and cons of debt consolidation?

In some instances, debt consolidation can help borrowers reduce their repayments or simplify them. For example, someone might take out a $7,000 personal loan at an interest rate of 8 per cent so they can repay an existing $4,000 personal loan at 10 per cent and a $3,000 credit card loan at 20 per cent.

However, debt consolidation can backfire if the borrower spends the extra money instead of using it to repay the new loan.

What is debt consolidation?

Debt consolidation is the process of rolling several old debts into one new debt, usually to save money or for the sake of convenience.

How do I consolidate my debt if I have bad credit?

The worse your credit history, the harder you will find it to consolidate your debts, because lenders will be less willing to lend you money and will charge you higher interest rates.

However, people with bad credit histories can make debt consolidation work by following this three-step process:

  1. First, find a lender willing to give you a bad credit personal loan. This process will be simplified if you go through a finance broker or use a comparison website like RateCity.
  2. Second, make sure the interest repayments on your new loan are less than the repayments on the loans being replaced.
  3. Third, instead of spending those savings, use them to pay off the new loan.

Does refinancing a personal loan hurt your credit score?

Personal loan refinancing means taking out a new loan with more desirable terms in order to access a more competitive interest rate, longer loan term, better features, or even to consolidate debts.

In some situations, refinancing a personal loan can improve your credit score, while in others, it may have a negative impact. If you refinance multiple loans by consolidating these into one loan, it could improve your credit score as you’ll have only one outstanding debt liability. Your credit may also improve if you consistently pay the instalments on time.

However, applying to refinance with multiple lenders could negatively affect your credit if your applications are rejected. Also, if you delay or default the repayment, your credit score reduces.

This article was reviewed by Personal Finance Editor Mark Bristow before it was published as part of RateCity's Fact Check process.