According to RBA's Financial Stability Review (October 2022), the resilience of household balance sheets is unevenly distributed across Australia.
Owing to higher interest rates and inflation, a small number of borrowers are experiencing a combination of high debt relative to their income and low saving and equity buffers. This makes them particularly vulnerable to financial disruptions.
If you're one of those borrowers and find it challenging to keep up with your repayments, you could consider debt consolidation refinancing.
Debt consolidation means combining all your different loans into a single consolidated loan. Debt consolidation, also known as refinancing, allows you more control over your financial situation.
A debt consolidation loan enables you to combine all your debts, such as credit card debt, personal loans and store cards, into one loan. This means you can start repaying all of your loans with a single set of repayments over a set period.
Consolidating debt helps you know exactly when and how many repayments you need to make. Even better, it means you only have to pay annual fees and interest on one loan, rather than multiple.
Many home buyers consolidate debts such as their car loan or a large credit card bill into their mortgage. In fact, refinancing to consolidate debt is very common among Aussie home buyers.
Refinancing for debt consolidation can be a suitable way to save money on monthly repayments and get your finances back on track. The following scenarios will demonstrate when it may be a good idea to explore this option:
Pam is a full-time working mum with two kids. She has a $400,000 home loan, which she took out 5 years ago at a 4% interest rate.
Since then, she has accumulated multiple debts, including credit card debt and a personal loan totalling $15,000.
Pam's salary after tax is $5,150 per month. After the monthly repayments of $2,560 on her existing debts, she's only left with a little to cater to other family expenses. This has resulted in her experiencing financial hardship.
She approaches a bank for debt refinancing. Her balance loan amount is now $348,000. Considering her stable financial situation, the bank adds the $15,000 of her other debts to the home loan balance. Pam refinances to a $363,000 mortgage for 25 years at the same interest rate of 4% p.a.
After consolidating her existing debts, Pam discovers that debt consolidation works to her advantage, lowering her monthly home loan repayments to $1,916.05.
James has two different credit cards with debts totalling $5,000 and $12,000 respectively. On top of that, he has taken out an investment property home loan with a debt of $250,000.
The debts have different interest rates, repayment amounts and schedules. Keeping track of mortgage repayments and other additional repayments gets a bit challenging for James.
James consolidates all his credit card and home loan debts into one loan to simplify his financial situation. He now does not have the hassle of multiple loans. Instead, there is just one set of regular repayments that James has to make over a set period with a single interest rate.
Furthermore, James will most likely be able to refinance to a lower interest rate than his existing debt. Consolidating debt thus enables James to reduce his overall debt.
Before you decide to refinance, you must understand how the process works. Here are some straightforward steps to help you get started.
The first step to refinancing is understanding the nature and extent of all personal debt. This includes the debt amount, interest rates and your monthly repayments. This step is critical to helping you determine if refinancing is suitable for you.
Our home Loan refinance calculator can help you determine how much you can save by switching your mortgage to a lower interest rate.
The equity held in your home refers to the amount you own compared with your home loan balance. For example, if your home is worth $600,000 and there's $200,000 left on your existing loan, you have $4o0,000 in equity.
Most lenders will allow you to borrow up to 80% of your property value. Typically, the more significant the chunk of home loan you've paid off, the better your chances of being approved for favourable refinance loan options.
Having determined your financial requirements and situation, you could contact your current lender to discuss a reasonable interest rate for your existing loan. Refinancing your home loan with your current lender helps you save some time in the process.
Your lender may negotiate a competitive, lower interest rate depending on your circumstances. This may help minimise some financial pressure from the interest portion of your loan repayments. Also, it will allow you to focus on attending to your other loans.
Suppose you cannot strike a suitable deal with your present lender. In that case, you look for another mortgage provider willing to offer you a home loan at a lower interest rate, along with features that match your circumstances.
After shortlisting suitable debt consolidation loans, calculate how much your monthly repayments will be with the new loan. The repayment amount on refinancing your home loan should be lower than all your current debt repayments combined.
Furthermore, you must also ensure that you factor in any potential new home loan fees, discharge fees on your old loan, legal fees, and other costs involved when you consolidate your debts.
Organise the paperwork required for refinancing your home loan, apply for a new home loan and consolidate your debts.
While it may be relatively easy for those with significant equity, it may be challenging if you have multiple debts. Working with a mortgage broker may help you find a deal to suit your individual circumstances.
Remember that consolidation of your home loan, car loan and other personal loans helps make your debt more manageable. Nevertheless, you still have to make the repayments on schedule according to the terms. Skipping repayments can result in late fees and increase your debt.
Typically, if you go with major lenders, you may be able to consolidate up to five different high-interest debts with your home loan. Most borrowers consolidate unsecured debts such as a car loan, credit card debt, personal loans and ATO tax debt into their home loans. Depending on your lender, the maximum amount could range from $50,000 and $100,000.
On the other hand, with most specialist lenders, if you have significant property equity to cover the debt and meet the required criteria, you may not have to worry about the amount limit for consolidating debt.
However, if you don’t have enough equity, in some cases, you may be able to apply for a part of your debt to be written off and the rest of it consolidated into your home loan.
There are significant benefits when opting for debt consolidation loans. These include:
For starters, when you consolidate your debts and refinance, your new loan interest rate will usually be significantly lower than the interest you would have to pay on your high-interest debt, including a personal loan, credit card, and/or car loan. By consolidating your debt into a single home loan with a lower interest rate, you'll be able to lower your repayments over the remaining loan term.
A single loan is easier to manage than multiple debts or cards across various credit providers. You'll need to attend to only one recurring repayment at a single interest rate.
Furthermore, since you only have to make repayments to one lender, it means less paperwork and time. This gives you more time to attend to your professional and personal matters.
A consolidated loan makes the repayment process simpler. Additionally, you’ll have more control of your budget and cash flow. Therefore, you will have more clarity on when you’ll pay off the loan and be debt free.
Furthermore, having a single, consolidated loan helps to manage your debt efficiently and improves your credit history in the long run.
Here are some of the potential drawbacks of refinancing your home loan to consolidate debt:
You will most likely have to pay exit fees on your existing loan and application fees for the new loan. Sometimes, these upfront refinancing costs can offset any interest savings you might make by consolidating your debt.
When you refinance to consolidate, you will convert your unsecured debts into debt secured by your home or property. So, if you are unable to make your mortgage repayments, your property lender will now be legally able to sell it and recover their money.
Suppose you have a home loan with a 20-year term, and you consolidate your debts and refinance to extend the term to 30 years. In that case, you will pay more interest over the loan term. The extended timelines also mean you may miss out on opportunities to invest that money elsewhere.
When you combine your other debts into your home loan, your LVR could be impacted. This may adversely affect your interest rates as some lenders charge a higher interest rate for loans with a higher LVR.
Furthermore, suppose your financial situation is unstable, and the lenders see you have a poor credit history. In that case, they may not allow you to refinance your home loan to consolidate debts.
Also, if your LVR increases to more than 80% due following debt consolidation, you will need to pay Lenders Mortgage Insurance (LMI) or risk fees. This could increase the overall cost of a debt consolidation refinance.
If you're thinking of refinancing to consolidate your debts, you should study the pros and cons to get an idea of what's best for your individual circumstances. Also, consider the following key factors:
When refinancing to consolidate debt, choosing the right loan type is critical. For example, though a low-interest home loan may sound more feasible, a longer loan term may be less stressful on your monthly budget.
At the same time, home loan rates are usually lower than credit cards and personal loans. So, consolidating them with your home loan makes regular repayments more affordable. Still, since home loans have an average repayment period of 20-30 years, you may have to pay more interest over time.
Therefore, before inking the deal, research loan products for different fees, features and rates for a suitable loan.
Review your existing debts, including your loan amounts, interest rates and repayments, and the cost of refinancing your loan. This will lay out your financial position and enable you to decide whether refinancing is right for you.
Often borrowers keep their credit facilities open even after consolidating existing credit card debts into a refinanced home loan. Be sure to close your existing cards because if you continue to use them, you'll accrue more debt. In addition, you'll have to pay account-keeping fees.
You could access expert resources to break out of a cycle of poor spending habits. Suppose you're finding it difficult to manage debt on your own. The Commonwealth Financial Counselling (CFC), run through local government departments, and National Debt Helpline, a not-for-profit organisation, offer services to help you tackle your debt problems. Debt counsellors are experts in helping you with ways to save your budget and plan expenses based on your income.
You could also consult a mortgage broker for help tailoring loans to suit your lifestyle and budget.
If you intend to consolidate all your debts and refinance your home loan, Joust can help.
Our Instant Match tool will help you access reputed mortgage brokers and lenders and connect you with up to 3 of our trusted partners. You can get to know their products, services and offers without the obligation to choose any of them.
So, if you're feeling overwhelmed by your debts, don't hesitate to give Joust a try!
Note: The information in this article is general in nature and should not be considered personal or financial advice. You should always seek professional advice or assistance before making any financial decisions.