Debt consolidation: 5 things to know before you consolidate in the new financial year

Rolling credit cards, a car loan and buy now, pay later into one repayment can simplify things. It only saves money if the rate, fees and term work in your favour.

Debt consolidation combines several debts into one loan and one repayment. It simplifies your finances but doesn’t reduce what you owe, and it only saves money if the new rate is lower and the term isn’t much longer. Before you consolidate, compare total interest, check fees on both sides, check your credit file and plan how you’ll avoid building the old debts back up.

The start of a new financial year is a common moment to take stock of existing debts.

If you are juggling multiple repayments across credit cards, a car loan, a personal loan and a few buy now, pay later accounts, the idea of rolling everything into a single monthly repayment is appealing.

Debt consolidation can be a useful tool, but it suits some situations better than others. Five things are worth understanding before deciding whether it is the right move.

1. Consolidation simplifies repayments but does not reduce what you owe

A debt consolidation loan combines multiple debts into one, replacing several repayments with a single monthly amount. What it does not do is reduce the total amount owed.

The benefit is simplicity and, depending on the interest rate, potentially a lower overall cost. But if the new loan carries a higher rate than existing debts, or the term is significantly longer, consolidation may cost more over time rather than less.

The term is easy to overlook. A lower monthly repayment can hide a higher total cost:

This example is for illustration only. It uses an assumed interest rate, excludes fees and charges, and is not a quote or an offer of credit. Your rate, fees and repayments will depend on the lender and your circumstances.

Stretching the same loan from three years to five lowers the repayment by about $220 a month but adds roughly $2,500 in interest.

2. Compare the overall interest costs and repayments

Consolidation generally makes more financial sense when the rate on the new loan is lower than the rates across existing debts. Credit card debt in particular often carries rates well above those available on a personal loan.

Comparing the rate on offer against current repayments is one way to assess whether consolidation could reduce overall interest costs. List each debt with its balance, interest rate, monthly repayment and time left to pay, then compare the total against the new loan’s comparison rate and total repayments. Our articles on whether consolidating debt saves you money and whether debt consolidation loans are worth it go through the maths.

3. Watch for fees on both sides of the transaction

Closing existing debts early can trigger break fees or early repayment charges, particularly on fixed-rate personal loans or car finance. The new loan may also carry establishment fees.

These costs are worth factoring in before committing, as they can reduce or eliminate the savings you were expecting. Getting a clear picture of fees on both sides gives a more accurate sense of the overall benefit.

4. Your credit file will likely affect the rate you are offered

The interest rate a lender offers on a consolidation loan is not fixed. It will be influenced by your credit history, income, existing debts and overall financial position.

If your credit file has some blemishes or your debt-to-income ratio is high, the rate offered may be higher than advertised rates suggest. Checking your credit file before applying gives you a realistic sense of what to expect and time to address any errors. Avoid lodging several applications at once, as each one adds an enquiry to your file.

5. Consider spending habits alongside any consolidation decision

One of the more common pitfalls of debt consolidation is paying off credit cards and buy now, pay later accounts, then gradually running them back up again.

The new financial year can be a useful moment to review spending habits at the same time as reviewing debt, including whether to close accounts that are no longer needed or reduce credit limits. Closing or reducing limits also helps if you plan to apply for a home loan, because lenders count your card limits against your borrowing capacity. Our guide to what affects borrowing capacity besides income explains how.

If buy now, pay later is part of the picture, read three things to know about buy now, pay later.

Is debt consolidation right for you?

Consolidation tends to work best when you have several higher-interest debts, a stable income, a clear plan to pay off the new loan within a reasonable term and a commitment not to rebuild the old balances. Read the benefits of debt consolidation for the upside, and our first-timer’s guide to applying for a personal loan for how lenders assess you.

If you are considering consolidating your debt heading into the new financial year, a finance broker can help you compare debt consolidation loans and other personal loan products across a range of lenders. Attain Loans is a finance broker in Melbourne’s west, and any loan is subject to each lender’s assessment.

This article is general information only and doesn’t take into account your objectives, financial situation or needs. Consider whether it’s appropriate for you and speak with a licensed professional before making a decision. If you’re in financial hardship, you can also contact the National Debt Helpline on 1800 007 007 for free financial counselling.

Further questions

This is general information only and is subject to change at any given time. Your complete financial situation will need to be assessed before acceptance of any proposal or product.