What Is Debt Consolidation?

Everything you need to know about debt consolidation. How does it work, what are the benefits and what you need to consider.

Juggling multiple debts can be both daunting and complex. Debt consolidation can help bundle all your existing debts together into one loan to provide you greater control and visibility of your overall financial situation. We discuss what debt consolidation, how it works, the potential benefits and what to consider before consolidating your debt.

What is debt consolidation?

A debt consolidation loan is to way to streamline all your debts into one loan, with one repayment, interest rate and term. This helps reduce the stress of managing multiple repayment schedules and accounts, and it also means you avoid having multiple annual fees.

How does it work?

A common method is to take out a new personal loan and using the funds to pay off your other existing debts. This new loan becomes the sole focus, with a single set of repayments, providing you clarity how much and when your repayments will be.

For example, you have two credit cards with outstanding balances of $3,000 and $4,000 respectively, and a personal loan of $7,000. Managing each of these debts can be complex as they can all have different interest rates, repayments, and due dates.

To simplify your financial situation, you can consolidate all these debts into one loan. This streamlines your payments into one set of recurring repayments, with one interest rate and a set term.

It’s important to note that you need to not only repay your existing debts from the new loan, but also make sure the existing accounts are closed and cut-up the credit cards to prevent further spending, otherwise you still have the same number of debts as when you started.

If the interest rate on this new loan is lower than your existing loans, this can also help you get ahead in reducing your overall debt faster.

What are the benefits of debt consolidation?

  • Simplicity – Managing one loan is more straightforward than juggling multiple loans from different lenders. It consolidates multiple repayments into a single monthly repayment with a single interest rate.
  • Budget control – With one loan, setting and committing to a repayment schedule becomes easier. It allows you to have a clearer understanding of when you’ll be debt free.
  • Potential improvement in your credit score – Having one, easy-to-manage loan can have a positive impact on your overall credit score.
  • Potential cost savings – It can save you money by either having reducing interest costs and/or fewer fees to pay, which you could use to pay or purchase other things.

What are some considerations before I consolidate my debt?

While there are several benefits to consolidating your debt, there are a few things to consider:

  • If you switch to a loan with a longer term, despite it offering a lower interest rate, the total interest and fees could be higher in the long run.
  • You need to ensure that you have a realistic budget that you can manage and stick to while trying to pay off your debt quicker.
  • Consider having your repayments scheduled soon after your payday to help you manage your budget and develop healthy budgeting habits.
  • If you’re adding other debt balances to your home loan, you may lose some flexibility in how you handle and pay off those debts.
  • You may need to contact each lender separately to make sure you close your other accounts and don’t continue to incur fees.

Debt consolidation is one of the benefits of refinancing. Learn more on what refinancing is and the benefits of refinancing.

This information has been prepared without taking into account your objectives, financial situation or needs. Before making any decisions, you should consider seeking independent legal, financial, taxation or other advice to check how this information relates to your unique circumstances.

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