October 2006

Save on repayments with debt consolidation

Debt consolidation is something of a buzzword these days. If your objective is to reduce interest rates that you pay on borrowed money and lower your monthly payments, to consolidate your bills and have one monthly payment, then a debt consolidation programme will help. Debt consolidation is very relevant in our current series on interest, because it can make a big difference to how much interest you pay on money you have borrowed.

Before investigating formal debt consolidation, it's worth mentioning that many people consolidate their own debt in some way – for example, by paying off their car loan using capital accessed from their home loan. Why can this be a good move? Let's say you have a car loan at 15% interest, and a home loan at 10% interest. If you have an access facility on your home loan and you have built up some equity, you can take some money out of the bond to settle your car loan, and therefore cancel the debt that has been attracting higher interest.

But be warned – this move is only for the financially disciplined. For it to save you interest, you must continue to pay the equivalent of your car loan repayment into your bond every month for the remaining term of your original car loan contract, e.g. 36 months. Always try to restructure debt over the remaining term of the original loan. Short-term debt (less than five years) should be repaid as soon as possible and not over 20 years (the average home loan period). This type of consolidation should not be used to reduce your overall monthly payments, it should be used to reduce your interest bill.

Then we come to formal debt consolidation, which is a facility offered by some banks. In simple terms, the bank will consolidate all your debt (credit cards, home loans and car loans, for example) into one loan – and offer you one, lower interest rate for the whole lump sum. The advantages are:

• Obviously, you save on interest, which means your monthly repayment is less than the combined total of your previous repayments. This means more money in your wallet at the end of the month (but don't spend it – save it).
• You only have to make one monthly payment instead of paying several creditors each month.
• You have the feeling that your debt is under control, rather than being scattered amongst various accounts.

It sounds great. Are there any catches? Not really, except that not everyone qualifies for formal debt consolidation. You have to be earning a certain minimum salary, and have a good credit record (a car repossession in your financial history will almost certainly disqualify you!). And it helps to have a solid asset base. The better your individual risk profile, the lower your interest rate will be. If you've lost control of your debt completely and you are behind with several payments, you'll need to rectify this situation first before thinking about formal debt consolidation.

Be aware that debt consolidation is not an instant facility, as it can take a few weeks for your bank to complete the process and for the paperwork on the cancellation of your original loans to be finalised.

To find out if debt consolidation is an option for you, ask your bank. Also, don't be reluctant to shop around – some banks might offer you a better consolidation rate than others.

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