How to consolidate your debts and save thousands of dollars in interest

Consolidating your debts can potentially save you hundreds if not thousands of dollars in interest over time.

It can be a great idea for anyone who has several credit cards, as well as personal and other loans. And with interest rates so low, there’s never been a better time to see how much you can save through this simple yet effective strategy.  

Debt consolidation involves taking out a new loan to combine all your debts into one loan facility. It can be useful if you accumulate a number of debts, for instance credit cards and personal loans, over a number of years, which become hard to manage due to high interest rates and conflicting and multiple loan repayment cycles.

Which debts can you consolidate?

A large range of debts can be consolidated into a new single debt facility, says Ryan Watson, chief executive of Melbourne-based financial advice firm Tribeca Financial. 

“These include credit cards, hire purchase agreements, as well as personal and car loans. Usually they are unsecured debts, that is, those that are not backed by an asset. So the debt facility attracts a higher rate of interest compared to a secured loan,” he said.

Chris Magnus, a financial adviser with Ark Total Wealth, says other debts can also be consolidated. “You can consolidate student loans, margin loans, utility debts, unpaid rent and debts to doctors or other professionals.” 

How do you consolidate your debts?

Magnus says there are a number of steps to take when consolidating your debts. “The lender will ask you questions to work out how much you can borrow if you are transferring your credit card debts to another credit card provider. You might also be asked to give them proof of your income including tax returns if you’re transferring a credit card debt to another credit card company.”

Although different lenders will have different processes, you’ll also need to prove your income if you’re borrowing from a bank and adding to your home loan. This will help the bank work out how much in total you are able to borrow. Also check with your bank to see if your credit score will be affected by consolidating your debts.

Watson says it’s a good idea to talk to a mortgage broker if you’re thinking about consolidating your loans. “A broker will accurately access your ability to consolidate your debts and find you a competitive interest rate, which will significantly reduce the interest you will pay over the life of the loan.”

What are the benefits to borrowers?

Debt consolidation offers two main benefits. A lower overall interest rate is the main one. “This should save you thousands of dollars in interest over the life of your loan,” Watson said. “It should also make it easier to manage your loan because you only make one repayment instead of several or more,” he adds.

Can you show me an example?

Here’s an example from Chris Magnus to show you how it works. Let’s say you have a $20,000 debt on your credit card with interest being charged at 18 per cent a year. This would cost you $3600 in interest a year, along with any principal repayments. You normally have to pay back a minimum of 2 per cent of the principal per month. 

This would take the total cost per year to $4800 in interest and $1200 in principal payments. This would take seven years and 10 months to pay off. If you transfer this to a transfer credit card at zero per cent for 24 months, you would save $3600 per year in interest and reduce the time it takes to pay off the loan by around three years.

“Beware of the interest payable after the interest-free term ends, as the rate could increase significantly,” Magnus warns. 

A similar principle applies to consolidating your debts into your home loan. You will pay far less interest on your home loan than your credit card. Some banks offer principal and interest loans at an interest rate of 2.2 per cent a year for owner-occupiers. This rate is much lower than the rate you would pay on a personal loan, credit card or car loan. 

It’s even more important to save money where you can during difficult or uncertain times. So pick up the phone to your bank or broker today to find out how much you can save through debt consolidation.