Columnist Peter Boehm

More and more Australians find themselves managing more and more debt. Ease of credit (particularly unsecured credit) and historically low home loan interest rates have combined to encourage many to take on more borrowings then they can reasonably afford. Paying off commitments like a home loan (or rent if you don't own a home), credit card, car loan, store card and unpaid utility bills to name a few can put severe financial stress on the family budget. Getting out of this financial straight jacket can be a tough challenge, particularly as the debt and interest continue to mount.

Getting your finances under control

A solution to help get your finances back under control is to consolidate all your debt into the one loan - the idea being that your monthly repayment and your interest cost would be less and more manageable.

Many believe debt consolidation is only available if you own a home and have sufficient equity to consolidate other debt into your home loan. While this tends to be the main consolidation route, you can still consolidate debt into a single unsecured loan, but this would be at a higher interest rate over a much shorter time frame. So the savings would not be as great - but there are still savings to be made.

How it works

Let's use an example of a household with home loan, a car and personal loan and outstanding credit card debt. Using the table below, you can quickly see how consolidating the unsecured debt into the home loan could result in some repayment savings.

Current position:

(# The household wants to pay off the credit debt in five years)

Post debt consolidation*

(* The calculation does not take into account any fees and charges relating to the existing debt or increasing the amount of the home loan)

In the above example, the household would save $383 per month, or $4,596 per annum.

Let's now take the same example but assume the household rents a house and is looking to consolidate into one unsecured loan.

Current position:

(# The household wants to pay off the credit debt in five years)

Post debt consolidation^:

(^ The calculation does not take into account any fees and charges relating to the existing debt or the new unsecured loan)

In this example, the household could save $122 per month or $1,464 per annum.

The advantages and disadvantages

There are a number of advantages and disadvantages to consider before embarking on debt consolidation.

The advantages:

• Lower monthly repayments and lower interest cost;
  
  
• Easier to remember due dates and track payments because there is only one debt to manage;
  
  
• No need to juggle or prioritise creditors;
  
  
• Protects your credit rating by avoiding the issue of default notices if debts go unpaid;
  
  
• Easier to prepare, manage and monitor your personal budget.
  
  

The disadvantages:

• If you are using a financial counselling service or a mortgage broker, be sure they have your best interests at heart and are not simply trying to earn fees and commissions. Weigh up and consider carefully the advice you're given. Think about using a not-for-profit counsellor if you're unsure or need more help;
  
  
• Your financial problems will not be solved unless you also change your spending habits. For example, consolidating credit card debt only works if you cut back on your spending;
  
  
• If you consolidate into your home loan, you're using up your equity and putting your home at risk if things go wrong;
  
  
• Home loan consolidation will undoubtedly incur lender fees;
  
  
• If your consolidated loan exceeds 80% of the value of your property, you will be up for Lenders Mortgage Insurance which could cost you many thousands of dollars, thereby reducing your overall cash savings;
  
  
• Consolidating shorter term debt into a longer term loan, while reducing monthly outgoings, will result in more interest being paid. Consider the example below where an unsecured car loan is consolidated into a cheaper home loan. As the table shows, the repayment saving of $161 per month is offset by an additional $5,076 of interest being paid over the life of the loan.
  
  

Making debt consolidation work

Here are some things to consider before and after you decide to consolidate your debt:

• Before you consolidate your debt, prepare a monthly budget to work out how much you can afford and how much you're looking to save;
  
  
• Look at your lifestyle and spending patterns. Try and identify those aspects that got you into your financial situation. Look for savings you can make on top of anything you may get from debt consolidation;
  
  
• The best way forward depends on your personal circumstances. For example, whether you have available equity in your home, whether you've had previous credit problems and how much you can afford to repay overall. Make sure you discuss your needs and options with a trained financial adviser or home loan expert;
  
  
• Avoid incurring new debts - this will only add to your problems. If you have multiple credit cards or other form of revolving debt, get rid of it;
  
  
• Make sure you meet your consolidated loan commitments on time every time - this should be your number one priority. Try and pay off the consolidated debt as soon as is practicable.
  
  
• If you're taking out a new loan to consolidate debt (for example, a new home loan product or an unsecured loan) make sure you assess the loan on its own merits, as well as how it might reduce your monthly outgoings. Look carefully at the terms, conditions, fees and charges and make sure you understand your rights and obligations. It's a good idea to shop around for the best deal.
  
  

Are you a first home buyer? Click here for all the info you'll need to make this important purchase.