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Jun 10 - Be warned of the risks in debt consolidation

Source: Resi Mortgage Corporation

In comparison to income growth, the escalation of household debt over the past 30 years has reached substantial levels.  According to the ABS, the last 18 years have seen the total amount of debt owned by Australian households to rise by almost six-fold.

These figures are not aided by the high interest repayments of credit cards of between 15-10 percent and personal loans having an average rate of 10 percent.  The burden of struggling to meet interest rate repayments can become overwhelming so the concept of consolidating these debts into your mortgage, where rates are around 7 percent, turns into a favourable option.

And with the current rising rate environment, the option of debt consolidation becomes a smart move but will it come back to bite you?

Consolidating debt works by placing all your high interest debts such as car loans, personal loans and credit cards together into one tidy repayment.  The intention is to merge debts into a low interest rate loan to maximise savings and lower repayments.  It’s most common that your mortgage is the debt that’s repaid on the lowest interest rates.

But it’s important to consider the consequences…

A personal loan, when consolidated into a mortgage could be cheaper in the long term in the form of reduced repayments, but the interest over a 30 year term could cost you thousands of dollars extra in accumulated interest.

Also when you consolidate, all your debts become secured and in the worst case-scenario and you could risk losing your house! – All because of a credit card debt or a personal loan.  So the advantage of keeping your repayments separated means that your personal loans stay unsecured and your home is not at risk if you don’t meet repayments.

Ultimately, consolidation is an option for only a limited number of people.  Nicole Rich of the Consumer Action Law Centre says, ‘if there is a big saving compared with your current outgoings, it might be the more favourable option.  But if you’re in genuine hardship, remember that you should contact your creditors where you should be able to negotiate lower repayments anyway.’

Nonetheless, the actions you take to minimise debt through consolidation should come hand in hand with a change in your financial behaviour. Borrowers should start living within their means and make the most of the short term savings they accumulate, merging their debt by getting control of unruly spending behaviour and understanding the power of budgeting.

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