Debt consolidation can save you a considerable amount of money.
Research by Canstar has revealed that consolidating credit card debt into a personal loan can save tens of thousands of dollars and years in repayments.
If you’re wondering whether you should or shouldn’t consolidate your debt into one loan, here are some factors to consider first.
Good versus bad debt
Before we delve into debt consolidation, it’s important to understand the difference between good and bad debt. Good debt is when you borrow to invest in an investment that produces more than the cost of borrowing. Good debt also refers to an investment that will increase over time, like property or shares. Bad debt occurs when you borrow money to invest, but the value of the investment declines over time. Bad debt includes things like a car loan or putting a holiday on a credit card.
What is debt consolidation
Over time, it’s easy to build up small debts here and there. Debt consolidation is taking all of your existing debts and repayments and consolidating them into one loan. Instead of making multiple payments, you will be required to make one or two.
For example, John has one fixed-term home loan and one variable home loan. He also a credit card with a $10,000 balance, another with a couple of thousand left, and a personal loan he took out for a holiday. Because of the multiple payments, it’s almost impossible for John to keep on top of his debts. It also means a lot of John’s money is paying interest and fees.
In this case it makes a lot of sense for John to put all his debts into one loan with as low an interest rate as possible. He can then make regular payments and reduce the amount of interest paid and potentially shorten the life of the loan as well.
Why consider debt consolidation
By consolidating your debts into one loan, you can get a clearer picture of what you owe and save money too. It’s often true that credit cards and personal loans come with a higher interest rate than your standard mortgage. In turn, this means you’re caught in a vicious cycle of paying off nothing more than the interest.
It’s also important to note that consolidating your debt means there is no credit facility. It’s a single lump sum that you have to pay back in its entirety. This means you can’t go reaching for more credit and as a result prevents you from incurring further debts.
Types of loans
If you’ve decided that debt consolidation, you have a few options available to you:
- Personal loan This involves consolidating all your debt into a new personal loan with a lower interest rate. Some personal loans have a single digit interest rate versus 20% on your average credit card.
- Balance transfer credit cards There are certain credit cards that will allow you to balance transfer personal loan debt. You will normally get 0% p.a. for a limited time, which means you need to manage your finances and pay off your debt within that promotional rate period.
- Refinancing through your mortgage When consolidating, it is extremely common to use the equity in your home. It’s important to note that while the lower interest rate is appealing, it is important to remember that the term of the loan is longer.
Once you consolidate your debt, it’s important to keep your finances on track. We’ve come up with a list of tips and tricks on how you can save money on a fixed salary.
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