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Debt consolidation: what is it and how does it work?

Posted on 8 July 2024

Debt consolidation can make managing debts convenient and stress-free. By consolidating all your debts into one loan, you can make repayments easier and save a significant amount of money. Read on to learn more about debt consolidation—how it works, its pros and cons, how to consolidate debt, and if debt consolidation is the right option for you.

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What is debt consolidation?

Debt consolidation is the process of combining separate debts into one larger loan. It involves taking out a single loan to settle multiple debts and streamline your regular loan instalment payments. It can help you achieve greater control over finances. 

If you consolidate loans into one payment, you may be able to get the benefits of lower interest rates, lower monthly payments, or both. This process can also help avoid multiple annual fees. 

A common way to do this is by taking out a new personal loan and using it to pay off your existing debts. Then, you only need to concentrate on repaying this single loan, knowing exactly how much and when to pay every month. ¹

How does debt consolidation work?

You can consolidate debts using various methods. For instance, you may apply for a new personal loan, a credit card with a higher credit limit, or a home equity loan. You can use the funds obtained with this new loan to pay off your smaller debts. 

For example, let’s assume you have one credit card debt of $1000, a car loan of $2000 and a personal loan of $7000. Each of these debts will likely have different interest rates, due dates, and repayment amounts which can make it tough to keep track of all of them.

To make your finances easier to handle, you can borrow one personal loan for debt consolidation. Now, you only have to make one payment each month for a specific period. If the interest rate on the personal loan is lower than your existing debts, it can also help you pay off your debt faster.

Debts that can be consolidated

You can consolidate a wide range of debts. Home furniture payment plans, credit cards, store cards, student debts, personal loans, ATO debts, mortgages, car loans and many more. The goal is to simplify your finances with one monthly payment, reducing the risk of missed payments and potentially lowering overall interest costs.

Debt consolidation loans: pros and cons

Now that you understand the debt consolidation process, you may be wondering is debt consolidation a good idea for you. Let’s look at why it can be a good option.

  • It simplifies the process of managing all repayments by clubbing them into a single monthly repayment.
  • You can reduce your monthly repayment amount by extending the loan term.
  • You can save money, either with lower interest or fewer fees to pay (or both)
  • You get a clearer timeline of when you’ll be debt-free.
  • You have greater control over your budget and cash flow.
  • You can potentially get out of debt much sooner.
  • A single easy-to-manage loan can have a positive impact on your overall credit score.²

However, consolidating loans comes with its own set of risks. Below are some of the pitfalls of debt consolidation that you should consider before deciding whether it’s the right option for you:

  • Consolidating debts may cost more despite lower interest rates, so you must check fees, penalties, and asset protection before committing.
  • Consolidating debt may lead to increased spending and a spike in overall debt because it offers access to more credit.
  • Defaulting on a secured loan can put your assets at risk.
  • Consolidated loans typically take longer to repay, potentially costing more in the long run.
  • With one loan, you have only one lender. This limits your negotiation options during financial difficulties.³

Debt consolidation may lower your credit score temporarily due to the hard credit check but can improve it in the long term if used wisely. Making timely payments often boosts the score and lowers overall debt.

Credit24: Personal loans for debt consolidation

How to consolidate debts

When you’re consolidating your debt, you should always explore all the available options before making a decision. If you go for it, make sure to do it right. Before you jump into debt consolidation, take your time to research lenders, understand the loan terms, and make sure the plan fits your financial goals. Rushing without planning could make your debt management tougher.

Before consolidating your debt

Here are a few things to consider before debt consolidation : 

  • Talk to Your Lender. It is advisable to talk to your mortgage provider in tough times. They may offer you a hardship variation by changing your loan term or reducing or pausing your payments for a while.
  • Switch Loans. If you have home loan debts, consider switching it as it could save you money in interest and fees. Only do this after exhausting the option of negotiating a better deal with your lender and calculating the benefits of the switch.
  • Credit Card Balance Transfer. This process can help you get on top of your credit card debts. Many credit cards come with promotional offers of lower interest or even 0 interest for a limited period.

    You can find one of these offers and use the credit to consolidate credit card debt. If you’re able to pay off your new debt within the offer period, you may save a lot on interest.⁴   
  • Get Free Counseling. Get free advice on debt management in Australia by calling the National Debt Helpline number at 1800 007 007. You can talk to a counsellor on weekdays between 9:30 am to 4:30 pm. Their live chat is active on weekdays between 9:00 am and 8:00 pm.

When consolidating your debt: tips and tricks

  • Do Your Research. Make sure the new loan will cost you less by comparing its interest rate and fees with your current loans. Ensure you can handle the new payments and check for penalties and extra fees. Be cautious with longer-term loans since they may end up costing more in the long term, even if the interest rate is lower.
  • Protect Your Assets. Try to look for unsecured loans to protect your assets. If you’re not sure if you’ll be able to pay back your loan on time, secured loans may put your assets at risk.
  • Choose Your Lender Wisely. Avoid lenders that make unrealistic promises and make sure the company is trustworthy and licensed before you take a loan from them. Make sure to discuss repayments and put all loan costs and the interest rate in writing before you sign the loan agreement.⁵
  • Read Loan Documents. Make sure to read the loan documents properly, including the terms and conditions. Since you’re putting your hard-earned money at stake, make sure you understand all the legal documents before you take out the loan.
  • Prioritise Repayments. If you don’t make your payments on time after loan consolidation, you may end up with more debt than before. So, prioritize repayment in your budget and try to make advance payments to take advantage of the consolidation process.

Personal loans for debt consolidation

You should consider taking out a personal loan for debt consolidation. Credit24 offers unsecured personal loans, so you can apply even if you don’t have collateral. The repayments are fixed upfront, so you’ll always know how much you’ll need to pay through the duration of your loan.

Our loan application process is quick and easy and payout can be done within a minute if the application is approved. Before applying, you can use Credit24’s calculator to check your potential monthly, weekly or fortnightly payments for the amount you want to borrow depending on the term of the loan.

Credit24: Consolidate your loans into one payment

Bottom line: is debt consolidation a good idea?

Consolidating debt can be a good idea if you have a strong credit score, can qualify for better terms, and can manage the new monthly payments. However, debt consolidation may not be the best idea for you if your credit needs improvement, your debt is minimal, or your financial situation is severe.

Disclaimer:
IPF Digital Australia Pty Ltd, trading as Credit24, ABN 59 130 894 405. Australian Credit Licence 422839. The information in this article is of general nature and does not take into consideration your objectives, financial situation or needs. Lending criteria, fees and charges apply. For more information about our products, eligibility criteria and terms and conditions, please visit www.credit24.com.au.

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