Refinancing to consolidate your debts

It’s quite common to accumulate a number of loans, particularly as you move through different stages of your life.

Perhaps you took out a personal loan or used a credit card to finance an overseas trip or a course you were interested in. Maybe you took out a car loan through a dealer several years later. Let’s say you also signed up to another credit card to get a great offer on frequent flyer points, which you then used to help finance your wedding. If you then take out a home loan as well, you could be looking at a pretty complicated debt trail, without really meaning for that to happen!

What’s wrong with having multiple debts?

There are several issues with situations similar to this:

1. Hard to keep track of repayments. You may find it confusing to have more than one or two loans, particularly with different lenders. You will most likely have repayments coming out of your account at different times, making it very difficult to keep track of your money and keep to a reliable budget.
2. More fees. You are probably paying fees of some sort on some, if not all, of your loans, which can really start to add up and is a waste of money.
3. High interest rates. Personal loans, credit cards and car loans typically have higher interest rates than home loans, so you could be paying more than you need to.

How to consolidate your debts

Refinancing debts and consolidating them into one loan can be a great way to save money and get back in control of your finances. Having just one lender, one repayment and one set of fees and finance policies to contend with is far simpler and – when set up properly – cheaper.

If you don’t have a home loan, you may be able to combine multiple debts into a special consolidation loan, usually a personal loan. This has the advantages of one set of fees, a much easier budget to manage and is typically cheaper than a credit card, however the interest rate is usually reasonably high.

If you do have a home loan, consolidating your debts by combining them with your home loan may be a better option as you can typically access a much lower interest rate than any other type of loan. Over the long term, this strategy should save you time, energy and money.

Make sure debt consolidation works for you

Obviously, the aim of refinancing to consolidate your debt is to put yourself in a better financial position. Your Mortgage Choice broker will help you to ensure this happens, however it’s important to be aware of the potential pitfalls such as:

1. Don’t turn short-term debts into long-term debts and pay more interest. Instead, set up your refinance repayments so that you are still paying the same each month as before the refinance. This will ensure that these extra debts are being paid off at least within the same time period (or faster if you have the funds).
2. Reducing your repayments to help with cash flow. This may be helpful if you know that you will be in a better financial position further down the track, but be aware that you will be accumulating more interest that will have to be paid off later.
3. Ensure you can afford to make your new home loan repayment amount. If you are consolidating your debt into your home loan, your home will become the security for all your debt so if you default on your repayments, your home could be at risk. If you are on a tight budget, consider a fixed rate on a fixed term as this can give you more certainty about your ability to make repayments in the future.
4. Switching fees. Depending on the lender, you may incur discharge fees, new loan fees or higher ongoing fees from your refinance. As you are increasing your loan balance, also check whether you will have to pay Lenders Mortgage Insurance, or any ‘penalty rates’.
5. Changes to your credit history. If your current credit score is worse than when you first took out your home loan, you may not qualify for the same conditions or benefits as that original loan.
6. Changes to the lending environment. Lenders can change how much they will lend different types of borrowers over time. This is due to economic and other factors. If lenders have tightened their lending policies since you took out your original loan, you may not be able to borrow as much when you refinance.

Usually, refinancing to consolidate your debts can be a very positive move to help you get your finances under control, keep to a budget and save money. Your Mortgage Choice broker can discuss any potential concerns depending on your situation and help you ensure the refinance will improve your financial position.