Roll Up, Roll Up ... Your Debts
Sydney Morning Herald
Wednesday August 9, 2006
The strategy: To consolidate my debts.
Do I want to do that? With the latest interest rate rise cutting into household budgets, there will be increasing pressure on cash-strapped households to save on interest repayments. The case is compelling. Let's say you owe $5000 on your credit card at the average interest rate of 17 per cent. Chances are that rate will soon be 17.25 per cent. You could roll that debt up into a personal loan or low-rate credit card at about 11 per cent. Or, if you have a home loan with a redraw facility, you could pay the debt off, effectively transferring the $5000 debt to your home loan with an interest rate of about 7.3 per cent. Over a year that could save you $300 if you consolidated at 11 per cent or about $500 if you used the home loan option. Obviously if you have higher or multiple loans, the savings are even greater. A further advantage of consolidating your debts is that you roll all your debts up into one (or two), saving confusion and possibly multiple fees. You have one regular repayment to make and it should be easier to focus on debt reduction.So how do I do it? The first step, says Indira Naidoo, a spokesperson for the Australian Consumers Association, is to make a list of your debts and interest rates. Obviously, the more expensive the debt, the more reason to consolidate it. Is it possible to move those expensive debts to an existing lower interest loan? Or do you need to take out a new loan to roll those debts up in? If you have a home loan with available equity, simply draw down that equity to pay out the expensive loans. Other options include getting an extension on your home loan, taking out a personal loan, or even transferring your credit card balances to a new, low-rate card. Naidoo says it's also important to look at the costs of consolidating. With some loans - including credit cards with honeymoon periods - there may be a penalty fee if you want to get out. Or you may incur fees setting up a new loan or extending your home loan. Naidoo says in some instances these fees can cancel out the benefits of consolidating. Also check whether there are any ongoing fees with the new loan that could reduce the benefits. Naidoo says another idea is to try to negotiate with your lenders. She says the ACA recently saw an instance where an individual owed $7000 on a credit card and was paying interest at 17 per cent. They approached the lender and were able to negotiate the rate down to 9 per cent. "Obviously if you're paying interest you're a profitable customer," she says.If I have a home loan, is that the best place to consolidate all my debts? It will almost certainly provide the lowest interest rate but, as with any loan consolidation, you'll need to be disciplined. The danger is that by rolling your debts up into your home loan, you'll take longer to pay them off and eventually end up paying more in total interest.How does that work? Let's take a $10,000 credit card debt. At an interest rate of 17.25 per cent you can pay it off in five years if you make a monthly repayment of $250 according to InfoChoice's calculator. You'll pay $4988 interest over that period. If you add the $10,000 to a 20-year home loan with a rate of 7.25 per cent you'll only need to make a monthly repayment of $79 according to InfoChoice. But you'll pay $8969 in interest before the debt is cleared.The trick, says InfoChoice's general manager, Denis Orrock, is to make sure you maintain your original repayments. If the person with that $10,000 debt had paid $250 a month into their home loan (instead of $79) after the debt consolidation, the extra $10,000 would be paid off in less than four years with a total interest bill of about $1480. "Lenders will advertise that they can lower your repayments but they're taking short-term debt and rolling it into 25-year-loans," Orrock says. "You need to keep making the same repayments and avoid incurring further debts outside [the consolidated loan]".
© 2006 Sydney Morning Herald
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