How debt consolidation can be your best friend or worst enemy
Debt consolidation, despite being used as a curse word for some people, is in reality a useful financial tool for the people who know how to use it.
These days, people take on all kinds of debt. Home loans, car loans, personal loans, credit cards, maybe even business loans. Even the most organised of debt reducers could end up developing a headache from the sheer amount of different debts they have – not to mention the various interest rates you have to keep in mind!
What debt consolidation does is it allows you to take all those debts you already have, and meld them into one. No more 18 per cent credit card with $5,000, no more $20,000, 10 per cent car loan.
Instead, you put all of those debts into one big lump, and repay it simply, easily, and often at a lower interest rate.
Best friend or worst enemy?
Credit cards aren't anathema to financial security.
This is where debt consolidation becomes either very helpful or downright dangerous.
If you consolidate your debts only to fall back into old habits, consolidation is going to do more harm than good. It eases off those high-interest debts (credit cards and personal loans in particular), and reduces them back down to more manageable interest rate levels through your home loan. But if you then just build up your debt again with a new credit card or a new loan, you'll find yourself right back where you came from with nothing to show for it.
Credit cards aren't anathema to financial security, so long as you know how to use them correctly – but irresponsible use and living the dream beyond your means results in nothing but heartbreak further down the line. We believe that you shouldn't need to reduce your lifestyle with better organisation, but a big part of that is knowing when to stop spending!
So when does debt consolidation become helpful? Let's give you an example. Let's say you've consolidated a principal and interest home loan ($300,000, $2,000 per month), a car loan ($20,000, $533 per month) and a credit card ($5,000, $200 per month) into one lump debt. The home loan would take you 25 years to pay off, the car loan would take you five years and the credit card (if you didn't use it again) would take you two years and four months.
After consolidation, you have a debt of $325,000, and let's say you are charged $5,000 for the set up costs. Because you have wisely gone for an interest-only loan (5 per cent), you are now paying $1,354 a month, instead of $2,433. That's a big difference right off the bat. But for the sake of argument, let's keep those repayments the same as before, and see what a difference it makes.
After 12 months, your debt is reduced down to $317,000. In two years and four months, you will have paid off the car loan and credit card. The total loan could be paid off in just under 12 years. Not 25 any more, but 12. Not only have you made your debt easier to manage, you've halved the amount of time it takes to pay it off!
Debt consolidation: not quite so evil after all, if you know what you're doing with it. This is just one of the techniques the property mentors at Think Money can teach you. For more tips, tricks and financial advice, make sure you get in touch with us today!