Debt consolidation is a personal finance strategy used by many Australians. When combined with more effective budgeting, improved debt management and a disciplined approach to future spending, debt consolidation offers many advantages relative to carrying several smaller but high cost debts. This article describes debt consolidation and the potential benefits it may have in regaining control of your finances.

 

Debt Consolidation for Australians


 

Many Australians have used debt consolidation loans to get the debt help they need to regain control of their personal financial situations. A debt consolidation loan makes it possible to pay off several debts and merge them into a single loan with a fixed and usually lower monthly payment. The lower payment reflects a longer maturity and an interest rate that is usually lower than the high rate loans that are paid off with the proceeds of the debt consolidation loan. Payments can usually be made on a weekly, fortnightly or monthly basis.

How a Debt Consolidation Loan Works


Most debts can be paid off and the balances consolidated into a single personal loan including credit card balances, vehicle loans, store card balances and personal loans that reflect earlier purchases. There are several advantages to having a single payment rather than several.

One major advantage of a debt consolidation loan is its cost, which is usually well below the aggregated cost of the several debts already outstanding. Credit and store credit cards have high interest rates on unpaid balances and any late payments will usually be reflected in late fees and potential upward adjustments in the interest rate charged. With several debts, it is not difficult to lose track and end up missing a scheduled payment but with a debt consolidation loan, the payment is fixed and the due date is known.

A single payment simplifies budgeting for monthly outgoings. Using a debt consolidation loan to pay off four credit card balances, a car loan, two store cards with interest accruing balances and two personal loans would result in one debt to track and pay rather than nine. This greatly reduces the likelihood of missed or late payments with their unpleasant results. It is easier to deal with only one creditor instead of several, potentially reducing the stress that comes from having one or more creditors following up to collect late payments.

A debt consolidation loan is best used as a strategy to regain financial control and improve your financial management moving forward, rather than as a short-term fix for a cash flow problem you may be having now.

Typical Terms


Debt consolidation loans usually have a term between two and seven years. Since the idea behind getting a debt consolidation loan is to have a predictable monthly cost, a fixed rate with constant monthly payments over the entire term of the loan is the typical choice. In most cases, the same procedures needed to apply for any personal loan are followed including proof of identity, credit checks, verification of employment, documentation of work earnings, a detail of all the applicant’s debts and other obligations and the value of the applicant’s assets.

The debt consolidation loan should clearly spell out any fees or expenses associated with the loan. In some cases, there may be an establishment fee, a monthly administrative fee and/or an early termination fee that applies if the loan is paid off early, usually within the first two years. Care should be exercised in fully exploring and understand all of the loan terms and whether or not there are any hidden fees.

Budgeting after Loan Consolidation


A debt consolidation loan becomes a single fixed line item on the budget. This makes it simpler and easier to develop and track a budget. The budget reveals the level of spending that is sustainable with the after-tax income. After consolidating debt, income and outgoings going forward should be balanced to avoid the use of borrowings to maintain current spending levels. If income exceeds expenses, consideration should be given to initiating a savings program to gradually build assets, rather than increasing spending.

Care must be exercised in avoiding the temptation to use the unused credit limits for financing new purchases on credit. Consideration should be given to reducing the number of credit cards and having the remaining credit limits reduced to the minimum comfortable level. Making purchases with a debit card is one of the more effective ways to avoid increasing debt to pay for daily expenses. The amount that can be spent on a debit card is limited to the balance in your bank account. An unwillingness to exercise restraint in spending will only lead to the need for debt help in the future.

This article is for educational purposes only and is not financial advice. Consult your financial adviser or other professional before making a decision about any financial transaction.