Debt consolidation and its benefits
Generally your home can provide the opportunity to secure the most cost effective debt available in the form of a home loan. As your home is used as recourse against the loan, it provides the lender with additional security allowing them to lend money to you with greater certainty and at a lower interest rate. Credit cards and other store loans are provided without security and therefore charge much higher rates of interest as lenders are unable to immediately gain access to your assets to seek repayments in the event of a default.
Usually, you will be financially better off utilising your home loan given the potential interest savings. However, this is not for everyone.
It is important to remember though that good budgeting, spending within your means and controlling your discretionary spending are the keys to getting ahead financially rather than continually spending borrowed money. A good savings and investment plan, and debt reduction strategy are important tools in securing your financial independence.
How it works
To ensure you are minimising the interest payable on a soon-to-expire interest free loan or credit card balance that is unlikely to be paid off in the foreseeable future, you may like to consider debt consolidation as part of your debt reduction strategy. This involves taking multiple debts and consolidating them into one loan with a much lower average interest rate. A home loan usually has the lowest interest rate.
|Debt||Balance||Interest Rate||Monthly Payment||Term (years)|
|Credit Card 1||$3,000.00||13.74%||$143.67||2|
|Credit Card 2||$6,500.00||11.99%||$305.95||2|
Consolidating your debts into your existing home loan at an interest rate of 4.2% could achieve a number of objectives!
Big tips for consolidating
Reducing your monthly repayments
In this example, in the event that you are unable to meet your monthly repayments, consolidating your debt will allow you to reduce your monthly repayments to $2,068.54 and allows you to regain control of your finances.
Reducing your interest paid
Ideally you should maintain your current monthly payments and aim to reduce your debt quicker to take advantage of a lower average interest rate enabling you to pay off your debt in 15.8 years and save $166,591.93 in interest.
If cash flow is important, there are other strategies you can explore such as consolidating your debt and splitting it into two loans to reduce your minimum repayment.
For example, split the loan into the original home loan of $380,000 and the second consolidated loan of $43,000. Then set the second loan term to five years and the minimum monthly repayment would be $795.80 and a monthly cash saving of $402.76, or $4,833.12 a year.
Alternatively, if your objective is to pay off your consolidated debt quickly but within the current monthly payment of $3,056.83, set your loan term to four years. If you pay 50% of the scheduled monthly repayment each fortnight, or even 25% of the scheduled monthly repayment weekly, a 30 year loan would generally be reduced by six years. Be careful though as a lot of lenders treat fortnightly repayments as scheduled monthly repayment x 12 then divided by 26 – still leaving you with a 30 year loan.