Debt can feel overwhelming, especially when juggling multiple repayments with varying interest rates and due dates. For many Australians, debt consolidation offers a way to simplify their finances, potentially saving money and reducing stress. But is it the right choice for you? Despite its advantages, there are still several aspects to consider before applying for a debt consolidation loan.

How does debt consolidation work?

Debt consolidation or refinancing is a financial strategy that involves combining multiple debts into a single loan or payment plan. The idea behind this option is to simplify the repayments for all existing loans with the aim to acquire a lower interest rate.

There are several options for debt consolidation, including personal loans, balance transfer credit cards, and home equity loans. Each option has its advantages and disadvantages, so it’s important to carefully consider the terms and fees associated with each option before choosing one.

What are my options for debt consolidation?

1. Personal Loans for Debt Consolidation

Personal loans are one of the most common ways to consolidate debt in Australia. Here’s how they work:

  • How It Works: You take out a new personal loan to pay off multiple existing debts. This leaves you with just one repayment to manage.
  • Interest Rates: Personal loans can be fixed or variable in interest rate. Fixed-rate loans provide repayment predictability, while variable-rate loans may offer more flexibility.
  • Unsecured vs Secured Loans:
    • Unsecured loans: No collateral is required, but the interest rate may be higher.
    • Secured loans: Require collateral, such as a car or property, and typically have lower interest rates.
  • Example Use Case: Combining high-interest credit card debts and smaller personal loans into one loan with a lower interest rate.

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2. Balance Transfer Credit Cards

This method consolidates credit card debt onto a single card with a low or 0% introductory interest rate.

  • How It Works: Transfer balances from multiple high-interest credit cards to a new credit card offering a promotional balance transfer rate.
  • Key Considerations:
    • The promotional period typically lasts 6 to 24 months, after which standard interest rates apply (often higher than average).
    • You may need to pay a balance transfer fee (e.g., 1–3% of the transferred amount).
  • Best For: Individuals with strong repayment discipline who can clear the balance before the promotional period ends.
  • Risk: If you fail to repay within the promotional period, interest charges may significantly increase your debt.

3. Home Equity Loans (or Mortgage Refinancing)

For homeowners, leveraging equity in a property can be a cost-effective way to consolidate debts.

  • How It Works: You borrow against the equity in your home and use the funds to pay off your debts. Alternatively, you can refinance your mortgage to include the amount of your consolidated debts.
  • Interest Rates: Generally lower than unsecured loans, as the loan is secured against your property.
  • Risks:
    • Failure to meet repayments could put your home at risk.
    • Extending the mortgage term might increase the total interest paid over time.
  • Best For: People with substantial equity in their property and the ability to manage long-term repayment plans.

4. Debt Agreements (Part IX Agreements)

A legally binding agreement between you and your creditors, facilitated through the Australian Financial Security Authority (AFSA).

  • How It Works: You propose to pay a percentage of your debts based on what you can afford. Once agreed, creditors are legally bound to accept the terms.
  • Eligibility: Only available to individuals meeting specific criteria, such as having unsecured debts under a certain threshold.
  • Benefits:
    • Avoids bankruptcy.
    • Consolidates all debts into one manageable repayment.
  • Risks: Can negatively impact your credit file for several years.

5. Debt Consolidation Through a Financial Institution

Banks and credit unions often offer specific debt consolidation loans.

  • How It Works: Financial institutions provide loans tailored for debt consolidation, combining multiple debts into a single loan with potentially lower rates and fees.
  • Key Features:
    • Can include multiple forms of debt, such as personal loans, credit cards, and store cards.
    • Some institutions offer flexible repayment options, such as additional payments or payment holidays.
  • Popular Providers: Institutions like Commonwealth Bank, NAB, and ANZ offer debt consolidation products.

6. Informal Debt Agreements

An alternative to formal debt agreements, informal arrangements allow you to negotiate repayment terms with creditors.

  • How It Works: You or a financial counsellor negotiate directly with creditors to reduce interest rates, waive fees, or create a manageable repayment plan.
  • Benefits:
    • Avoids formal agreements, which could impact credit scores.
    • More flexibility in negotiating terms.
  • Risks: Creditors are not obligated to agree, and the arrangement may not cover all debts.

7. Using a Debt Consolidation Service

Several private companies and not-for-profit organizations specialise in helping people consolidate debts.

  • How It Works: These services negotiate with your creditors on your behalf to consolidate debts into a single repayment.
  • Examples: Companies like Fox Symes offer tailored debt consolidation solutions for individuals struggling with multiple debts.
  • Considerations: Be cautious of fees and ensure the company is reputable and licensed.

8. Salary Sacrifice Arrangements

In some cases, employers may allow you to use salary sacrifice to manage debts.

  • How It Works: A portion of your pre-tax income is used to repay debts or fund a consolidation loan.
  • Benefits: Can reduce taxable income and make debt repayments more manageable.
  • Risks: Requires employer agreement and may limit disposable income.

9. Debt Consolidation via Superannuation

Under financial hardship provisions, you may be eligible to access your superannuation early to pay off debts.

  • How It Works: Withdraw a portion of your super to settle outstanding debts.
  • Risks: Diminishes your retirement savings, potentially leaving you financially vulnerable later in life.
  • Eligibility: Subject to strict criteria, including demonstrating financial hardship.

When should I consider consolidating my debts?

  • You have too many existing loans that you struggle to pay for
  • You find yourself making numerous payments each month for all your existing debts
  • You sometimes forget to repay some of your loans because of the multiple credit accounts you have
  • You are having a difficult time keeping up with the high-interest rates on your loans

Carefully weighing the costs and benefits of debt consolidation is essential, as it could come with higher fees or interest rates compared to your existing debts, potentially increasing the overall cost over time. Moreover, while consolidation simplifies your repayments, it may not tackle the underlying causes of your debt. Without addressing spending habits or financial discipline, there’s a risk of falling into deeper financial trouble if credit is used irresponsibly.

Below are some related articles to help you address your spending habits:

When is debt consolidation a bad idea?

  • When the interest rate is higher than existing debts – If the consolidation loan has a higher interest rate than your current debts, it may increase the overall cost of your debt rather than reducing it. This can happen if your credit score isn’t strong enough to qualify for favorable rates or if fees associated with the new loan are substantial.
  • If it extends your debt term significantly – While consolidating debt can lower your monthly repayments, it often does so by extending the repayment period. A longer term means you might end up paying more interest over time, even if the monthly payments feel more manageable.
  • If you’re at risk of accumulating more debt – After consolidating debt, the accounts you’ve paid off may remain open. If you start using those credit lines again, you could end up with even more debt, compounding your financial challenges.
  • When it involves risking secured assets – If you use secured debt consolidation options, such as a home equity loan or refinancing your mortgage, you’re putting your property at risk. Missing payments could result in losing your home, which might not be worth the trade-off if you’re unsure about your ability to meet the repayment schedule.
  • When consolidation fees are excessive – Debt consolidation often comes with fees, such as loan establishment fees, balance transfer fees (on credit cards), ongoing account fees, or early repayment penalties (on existing loans). If these fees outweigh the potential savings from consolidating, it might not be a financially wise decision.
  • If your debt is manageable without consolidation – If you can manage your debts by adjusting your budget, negotiating with creditors, or making extra repayments, consolidation might not be necessary. In such cases, it’s better to focus on direct repayment strategies rather than incurring additional costs through a consolidation loan.
  • When you’re close to paying off your debts – If you’re nearing the end of your repayment schedules for existing debts, consolidating might not save you much money. Instead, it could introduce unnecessary costs or prolong the repayment period.
  • If you’re considering bankruptcy or a debt agreement – In some cases, financial distress may make bankruptcy or a formal debt agreement a better option. These alternatives can provide a fresh start, whereas debt consolidation might just delay the inevitable if your financial situation is unsustainable.

Additionally, always remember that debt agreements, also known as Part IX (9) debt agreements, are not the same as debt consolidation and should be approached with caution. These are legal agreements between you and your creditors to pay off your debts over a specified period, often with reduced payments. Debt agreements are acts of bankruptcy and can have long-term consequences, including negatively impacting your credit report for up to five years.

Before applying for any credit or loan product, including a debt consolidation loan, it’s important to understand the terms and conditions, including any fees and interest rates. Multiple applications for credit in a short period can also negatively affect your credit score, so it’s crucial to carefully consider your options and seek professional advice before making any applications.

As suggested, seeking the help of a financial counsellor can be a good starting point to assess your financial situation and explore all the available options. Financial counsellors are independent and can provide free advice and support to help you manage your debts and improve your financial situation. The National Debt Helpline is a useful resource to connect with a financial counsellor and access free advice and support.

Advantages of debt consolidation

Debt consolidation can offer several advantages for individuals who are struggling with multiple debts. Here are some of the advantages of debt consolidation:

  • Make repayments easier – Consolidating your debts can certainly simplify your repayments and help you better manage your finances. By combining multiple debts into a single loan, you only need to make one repayment per month, which can help you stay on top of your finances and avoid missed or late payments. This can be especially helpful if you have multiple debts with different repayment schedules, interest rates, and fees, as it can be hard to keep track of everything and ensure that you’re meeting all your obligations on time.
  • Cut back on the cost of paying off your debts – Additionally, consolidating your debts into a single loan with a lower interest rate may help you save money in the long run. This is because you’ll be paying less in interest charges, which can add up over time. It’s important to compare the interest rates and fees of your existing debts with those of the debt consolidation loan to ensure you’re getting a better deal.
  • Set a date to end your debt – One of the most constructive benefits of consolidating debt with an unsecured personal loan is its fixed term – the end date is built into the loan, which means you have a goal to work towards in paying your debt down. With a clear end date in sight, you can create a plan to pay off your debt and work towards a debt-free future. It also means that you won’t be caught in a cycle of paying minimum repayments indefinitely, which can result in paying more interest in the long run.

Disadvantages of debt consolidation

While debt consolidation can offer several advantages, there are also some potential disadvantages that you should be aware of. Here are some of the disadvantages of debt consolidation:

  • Extended repayment period – Consolidating your debts can help you lower your monthly payments by extending the repayment period of your loan. However, this can also mean that you end up paying more interest over the life of the loan, which can increase the total cost of your debt.
  • Fees and charges – Some debt consolidation loans may come with fees and charges, such as balance transfer fees, origination fees, or early repayment fees. These fees can add to the cost of the loan and reduce the overall savings you may have achieved by consolidating your debts.
  • Risk of accruing more debt – Consolidating your debts may provide temporary relief from debt, but it’s important to address the root cause of the debt problem. Without changing the underlying behaviour that led to the debt, there is a risk of accruing more debt in the future.
  • Impact on credit score – Applying for a new loan or credit card to consolidate your debts can result in a temporary dip in your credit score due to a hard inquiry. Additionally, if you close any of your credit card accounts after consolidating your debt, it can also impact your credit utilisation and credit score.
  • Not all debts can be consolidated – Some types of debt, such as tax debt or student loans, may not be eligible for debt consolidation. This can limit the effectiveness of debt consolidation as a strategy for some individuals. Make sure to consider these advantages and disadvantages of debt consolidation before deciding if it’s the right strategy for your specific financial situation. Working with a financial professional can also help you evaluate your options and make an informed decision.

Your 5-Steps to Consolidate Debts

STEP 1: Assess Your Finances
List all your debts, including amounts, interest rates, and repayment terms.

STEP 2: Compare Consolidation Options
Research various options, focusing on interest rates, fees, and repayment terms.

STEP 3: Seek Financial Advice
Speak to a financial counsellor or trusted advisor to ensure consolidation aligns with your goals.

STEP 4: Apply for the Loan
Submit your application and provide necessary documentation. Ensure you fully understand the terms and conditions.

‼️Be cautious in transacting with lenders, especially those who offer loan services online. Double check their legitimacy and make sure that they have a valid credit license in Australia like us here on Friendly Finance  ‼️

STEP 5: Stick to Your Plan
Commit to your new repayment schedule and avoid incurring additional debt.

Debt consolidation isn’t a one-size-fits-all solution. It’s most effective for individuals with multiple debts and a plan to address underlying spending habits. If you’re unsure, seek guidance from the National Debt Helpline (1800 007 007) or consult ASIC’s MoneySmart platform for free financial advice.

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