I Can Do That...
Sydney Morning Herald
Wednesday May 26, 1999
The strategy: Wrap all my debts up into one and reduce my interest payments.
Why would I want to do that? Two reasons. Dr Vern Harvey, chief executive of the Credit Union Services Corporation, mostly associates debt consolidation with people who are in trouble with their borrowings - often through expensive store credit and credit cards. For these people, debt consolidation means rolling borrowings into one loan with a fixed interest rate and a fixed repayment schedule - subjecting themselves to a degree of discipline. In its looser usage, debt consolidation is also increasingly being used to refer to people rolling existing debts - such as the car loan, the boat loan and credit card debts - into their home loan, usually using a home equity facility. In both cases, the attraction is a cheaper interest rate and a simpler administrative package (one repayment instead of several); the opportunity to manage your debt better.
So how is it done? "If you're in financial trouble," says Harvey," it's not easy." You need to draw up budgets and an achievable repayment schedule and convince a lender (preferably one you already have a relationship with based on a good repayment record) to provide you with a new loan package. In most cases, Harvey says, the consolidation will be through a personal loan and the interest rate will depend on how good (or poor) a credit risk you are. If it's the home loan option you're after, a home equity loan can let you access the equity you have built up in your home. Here, it's a matter of drawing down that excess equity to pay off your other debts. Borrowers not in financial difficulty could also look at consolidation through a personal loan - although, Harvey says, the benefits can be marginal.
How does it work? Let's say you have $20,000 in "bitsy" loans - $5,000 outstanding on your credit card at 15 per cent, a $10,000 caryard loan at 15 per cent over five years, and a $5,000 personal loan at 11 per cent for three years. If you are a reasonable credit risk, you may be able to consolidate these loans at an interest rate of about 9 per cent. It's not cheap, but it is certainly cheaper than what you're paying now. And, unlike credit card borrowings, you are required to commit to a loan repayment schedule to ensure the loan is paid off.
Alternatively, let's say you also have a $100,000 home loan on a property now worth $170,000. That's $120,000 in borrowings that could all be rolled into your home loan. By extending your home loan, you could reduce the rate you're paying on all your loans to the standard variable rate - currently about 6.5 per cent - and reduce your various monthly repayments to just one.
So what's the catch? You'll usually have to pay a fee to change your loan arrangements. And if your repayment record has been poor, your bank may not be falling over itself to extend you extra credit. But the real danger lurks in your own behaviour. Debt consolidation can be fantastic if you use it as an opportunity to get serious about your loan repayments and get rid of this consumer debt as quickly as possible. Unfortunately, it's easy to spend the money you're saving on your loan repayments instead of using it to repay your debt. If you're looking at the home equity loan option, you could be paying your car off over the length of your home loan - as long as 25 years - instead of over five years. That will cost you significantly more in total interest charges and is really a mug's game. Credit counsellors warn to be careful not to incur any new loans once your debts have been consolidated. Unfortunately, it's all too easy to start the whole cycle of building up loans over again.
© 1999 Sydney Morning Herald
