How debt consolidation home loans work
A debt consolidation home loan combines all your existing debts into your low-interest home loan. This is an effective strategy when:
You have built up a level of equity (ownership) in your home over time. For example, through it increasing in value and/or you making your regular repayments. You can then borrow against that equity to consolidate your high-interest debts.
Suppose you owe $400,000 on your home that’s worth $600,000 and that your hone loan interest rate is 4%. Your equity would be $200,000 (i.e. $600,000 less $400,000).
Also assume that you owe $50,000 on personal loans and credit cards at an average interest rate of 10%. You can take out a debt consolidation home loan to incorporate the additional $50,000 debt at your lower 4% home loan rate.
You increase your home loan repayments to cover the consolidated debt.
You don’t get any further into debt.
Debt consolidation loan FAQS
Is it a good idea to get a debt consolidation loan?
It’s a good idea to get a lower-interest debt consolidation loan if you’re struggling to repay multiple debts at high interest rates. The alternative is to miss repayments, which can hurt your credit score and potentially see you get assets repossessed if you have a secured loan.
Do consolidation loans hurt your credit score?
Every time you apply for credit, your credit score can temporarily drop slightly. However, if you then start making all your repayments on time and reduce your overall level of debt, your credit score will improve. It’s easier to do that with a low-interest debt consolidation loan.
What credit score do I need for a debt consolidation loan?
This depends on the lender’s criteria, but you will usually need a credit score of around 650 or higher. You may be able to get a debt consolidation loan with a lower score, but you’ll usually be charged a higher interest rate.
You can check your credit score for free with credit reporting agencies like Experian before you make your debt consolidation loan application.
What is the smartest way to consolidate debt?
The smartest way to consolidate debt is to avoid extending your debt or credit term unless it’s absolutely necessary. In other words, don’t turn short-term debt into long-term debt just to lower your repayments. If you do, you’ll end up paying more interest in the long run, even with a lower interest rate on your debt consolidation loan.
You should continue with the same overall debt repayment amount when you take out a consolidation loan. This will allow you to pay off your debt faster and to pay less interest. A debt consolidation loan is a good strategy if you’re committed to reducing your overall debt level.
What are pa comparison rates?
pa’ is an acronym that stands for ‘per annum’, which means ‘per year’. A ‘comparison rate’ is the cost of interest plus any loan fees and charges. You should always use the comparison rate when evaluating the total cost of different loan products. The loan with the lowest comparison rate is the cheapest.
How much can you save with a debt consolidation loan?
This depends on a range of factors including the:
- loan amount,
- loan terms and conditions, and
- the comparison interest rate on your consolidation loan versus the rates on your other debts.
The table below shows the annual interest charged on $50,000 worth of multiple debts at a range of loan interest rates. As you can see, a lower interest rate makes a significant difference.
(10% comparison rate)
(7% comparison rate)
(4% comparison rate)