Debt consolidation can be tempting at this time of the year and works well for many people, but there are traps for those who don’t understand how it works.
The idea of combining all your consumer debts into one simple loan and repayment is growing in popularity.
New data from peer-to-peer consumer lender Society One shows that more than 60 per cent of its loans are taken out to consolidate debt, followed by home improvements (11 per cent) and vehicle finance (8 per cent).
SocietyOne CEO Mark Jones said Australians were becoming more financially savvy about debt.
He said younger generations in particular were scrutinising traditional financial products such as credit cards.
“The biggest benefit of debt consolidation is the potential to make big savings on your interest bill,” Mr Jones said.
“Consolidating multiple forms of debt into one lower-interest loan could result in hundreds if not thousands of dollars slashed from your overall interest bill.”
However, not all loans should be consolidated, especially if there are no interest savings.
“As an example, student loans often have quite low interest rates and may not be appropriate for consolidating,” Mr Jones said.
He said borrowers should also read the fine print and check for extra fees or prepayment penalties, which could undermine savings.
And avoid making multiple loan inquires that can dent your credit score.
Borrower Mia Chong benefited from a debt consolidation loan, which saved her interest and helped her buy a property faster.
“I had a couple of little loans and it was bothering me that I was paying interest on each,” said Ms Chong, a paediatric clinical nurse consultant.
“Keeping track of when the different payments were due was also a huge inconvenience, and I was always worried I might accidentally miss a repayment.”
Financia managing director Angelo Benedetti said more people were consolidating consumer debt into mortgages at interest rates below 4 per cent.
“With credit cards, a 20 per cent interest rate is an exorbitant amount of interest to be paying and getting nowhere,” he said.
Mr Benedetti said people who consolidated should try to pay their debt down quickly rather than spread it over 30 years. “Force yourself to pay over and above the base repayment.”
SHOULD YOU CONSOLIDATE?
• Understand your exact financial situation and work out which debts to prioritise.
• If your problem is bigger than you thought, call the National Debt Helpline on 1800 007 007.
• Compare loan products but don’t make multiple inquiries that might ding your credit score.
• Have a realistic budget that shows how much money is free to pay down the debt.
• Set up automatic transfers so you never miss a repayment.
Originally published as Know the traps before consolidating debts