How do debt consolidation loans work?

Put your good credit history to work with a personal loan for debt consolidation.

Wondering how to consolidate debt? Debt consolidation loans aren’t a big mystery – they’re simply personal loans specifically for debt consolidation. To understand them, you simply need to understand loans.

What to look for in a debt consolidation loan:
Whether it’s a personal loan for holiday or a personal loan for debt consolidation, all loans have the same building blocks. It’s about finding the right fit for you.

Interest rate
Money costs money. So when you borrow it, you need to pay it back with interest. The interest rate, also known as Annual Percentage Rate (APR) or Advertised Rate, is the percentage that you’ll pay on top of the amount you borrow. It’s usually expressed as an annual rate. 

How is interest calculated? To work out your rate, lenders will factor in things like your credit history, your repayment schedule, the risk (both for lending to you and how the market is going) and their underlying costs.

Most lenders start with a headline advertised rate – the lowest rate they have available. But they might not offer you this rate – it’s usually only available to a small proportion of borrowers and may come with set conditions to qualify (e.g. a high credit rating plus homeownership).

So, it pays to do your research. Before you apply anywhere, get a personalised rate from a number of providers. Just be sure that the lender’s quote process is ‘credit score friendly’. That is, they only conduct a soft check on your credit file which won’t impact your credit score.

Remember, the loan with the lowest interest rate might not necessarily be the best loan for you. Be sure to consider the total cost of the loan including interest, fees and other costs to truly assess the value of any interest rate on offer.

Comparison rate
Interest isn’t the only cost of a loan; it will usually come with fees and other charges. These can be quite significant and quickly outweigh a great rate. To avoid getting caught out, look at the comparison rate, which factors in the interest rate and any fees, expressed as an annual percentage. The comparison rate is usually higher than the interest rate charged on the loan.

Because it’s so important, lenders and brokers must provide a comparison rate when they advertise a loan interest rate under the National Consumer Credit Protection Regulations.

How is it measured?
For personal loans, there is a standardised measure for how comparison rates are to be calculated and displayed. For variable and fixed-rate personal loans, the comparison rate is based on a $30,000 unsecured loan over 5 years.

But there’s a catch – not all costs are included. So you don’t get an unwelcome surprise later, you still need to factor in:

• Late payment fees
• Break costs or early termination fees
• Deferred establishment fees
• Broker fees (when taking out a loan through a broker, the broker’s service fees aren’t included in the comparison rate, which can be significant)
• Repayments

Once you’ve got all your ducks in a row and consolidated your debt into one loan,it’s time to repay the money. During the loan process you’ll agree to a regular schedule for repayments – either weekly, fortnightly or monthly. Factor these repayments into your budget and be sure that your loan repayment calculations have been quoted inclusive of any ongoing fees.

Your lenders might also offer a balloon payment, which is a lump sum repayment you make at the end of the loan term. It can reduce your regular repayments, making it a handy way to manage your cash flow. But remember, the lump sum is due at the end of the loan, so you still need to find the money along the way. You’ll also be paying interest on a higher loan balance as you go.

Upfront fees
Also known as application or establishment fees, they’re ‘one-time’ charges at the start of a loan that get the ball rolling. They can include:

• A flat fee (e.g. $499) that applies regardless of the value of the loan
• A tiered fee (e.g. $250, $500, $750) based on the value of the loan
• A percentage fee (e.g. 3%) based on the total amount borrowed and the credit or risk profile of the customer
• A hybrid fee (e.g. $200 + 2% of the loan amount)

Your lender may charge any or all of these, it’s up to them.

But, fun fact, even though they’re called ‘up front’, that’s not when you pay them. Establishment fees are usually capitalised to the loan, meaning they’re added to your loan balance.

That means you’ll be paying interest on those fees as part of your total loan. The difference might be only a few dollars on each repayment if it’s a small upfront fee. But if it’s bigger, it can quickly add up.

Monthly or ongoing fees
Your lender may charge any or all of these, it’s up to them.

Even though they’re called ‘upfront,' that’s not when you pay them. Establishment fees are usually capitalised to the loan, meaning they’re added to your loan balance.

That means you’ll be paying interest on those fees as part of your total loan. The difference might be only a few dollars on each repayment, if it’s a small upfront fee. But if it’s bigger, it can quickly add up.

Also known as account keeping or loan management fees, ongoing fees are usually paid monthly across the life of a loan. They don’t reduce what you owe at all, they just go straight to the lender. Generally the lower the fees, the better. But again, it’s all relative to the total amount you repay when you factor in all interest payable and costs.

Brokerage fees
If you use a broker to help track down your loan for you, remember they’re doing a job. That means you’re paying them, whether you realise it or not.

In the case of personal loans, the brokerage fee is often capitalised to the loan amount and is in addition to the lender’s own upfront fee. Brokers can also have commission arrangements with lenders that are either built into your interest rate or offer them a return based on the final rate you accept. Be sure to factor that in when deciding if their services are worth it.

Penalty fees
Nobody ever takes out a loan expecting to pay penalty fees. But life doesn’t always go to plan. The best you can do is try and minimise the damage.

The most common penalty fee is the ‘default’ or missed payment fee. If you make a payment late, or there are insufficient funds in your nominated account on the day a payment is due, you can get slugged with this fee.

Late fees vary from $10 to as much as $35. Some lenders may waive the fee if your account is brought up to date within 3 days of a missed payment, but it’s best not to risk it. Be sure to keep an eye on your spending and make sure you have enough in your account to pay the loan. Some borrowers even  set up a separate account dedicated to paying their loan.

Early repayment fees
If you think you want to pay your loan down ahead of schedule, look for a loan with low or no early repayment fees. Otherwise, all your hard work may go to waste if you get charged for it.

Exit fees or early repayment fees are more common with secured low-rate loans. There are different types

Ongoing fees, also known as account keeping or loan management fees, are usually paid monthly across the life of a loan. They don’t reduce what you owe at all, they just go straight to the lender. Generally the lower the fees, the better. But again, it’s all relative to the total amount you repay when you factor in all interest payable and costs.

Brokerage fees
If you use a broker to help track down your loan for you, remember they’re doing a job. That means you’re paying them, whether you realise it or not.

In the case of personal loans, the brokerage fee is often capitalised to the loan amount and is in addition to the lender’s own upfront fee. Brokers can also have commission arrangements with lenders that are either built into your interest rate or offer them a return based on the final rate you accept. Be sure to factor that in when deciding if their services are worth it.

Penalty fees
Nobody ever takes out a loan expecting to pay penalty fees. But life doesn’t always go to plan. The best you can do is try and minimise the damage.

The most common penalty fee is the ‘default’ or missed payment fee. If you make a payment late, or there are insufficient funds in your nominated account on the day a payment is due, you can get slugged with this fee.

Late fees vary from $10 to as much as $35. Some lenders may waive the fee if your account is brought up to date within 3 days of a missed payment, but it’s best not to risk it. Be sure to keep an eye on your spending and make sure you have enough in your account to pay the loan. Some borrowers even  set up a separate account dedicated to paying their loan.

Early repayment fees
If you think you want to pay your loan down ahead of schedule, look for a loan with low or no early repayment fees. Otherwise, all your hard work may go to waste if you get charged for it.

Exit fees or early repayment fees are more common with secured low-rate loans. There are different types:

• A fixed fee where the loan is repaid in full any time prior to the end of the loan term (e.g. $500)
• A fixed fee where the loan is repaid in full prior to a minimum period (e.g. $250 if full repayment is made less than 2 years into a 5-year loan)
• A variable fee based on the amount you would have paid in interest and fees had the loan run to full term

Loan amount
How much money do you need to repay your existing debt? Add it up and that’s your loan amount (plus those upfront fees). This is the principal part of your loan that you’ll make repayments on. Interest is charged on the outstanding balance of your loan.

In Australia, debt consolidation loans usually range from $2,000 to $65,000, but some lenders will go higher.

Loan term
A debt consolidation loan gives you the space you need to pay off your debt over time. In Australia, lenders offer loan terms between 1 and 7 years, with 3, 5 and 7 year terms being the most common.

If you’re tempted to take your time, just remember, a longer-term loan might have a higher interest rate, meaning loan will cost you more overall. But when it comes to cash in the bank, your monthly repayments will be lower. Do your sums and choose what’s right for you.

Customer experience
Whilst not technically part of your loan, it’s the X factor that can make all the difference on your journey to financial freedom. Because the best way to consolidate debt into one payment is with a lender that cares.

You want a lender who makes it quick and easy to apply, get approved and manage your loan. And if you have a problem, you want a lender that cares about your experience. It can go a long way towards trusting you’re getting the best deal.

Anything else?
A debt consolidation loan can affect your credit score, and unfortunately, things usually get worse before they get better. Opening a new credit account temporarily lowers your credit score. Lenders look at new credit as a new risk, causing a temporary dip in your score. You can fix this by paying your new consolidated debt on time – that should bump it up higher than before.

What can I use my debt consolidation loan for?

Consolidate credit card debt, car loans, even overdrafts – it’s up to you.

There aren’t many rules when it comes to debt consolidation loans. As a personal loan, you’ll have your own personal reasons. So whether it’s to consolidate credit card debt and save on high-interest rates, or combining car finance with other personal loans to make managing your monthly repayments easier, the choice is yours.

For life’s little expenses

You can use a debt consolidation loan to repay a number of debt types, including:

• credit cards
• personal loans
• store cards 
• overdrafts
• car loans
• lines of credit

For taking the wheel
If you have repayments for credit cards, student debt, store cards and more all due on different days of the month, it can be tricky to keep track. You risk getting confused about what’s due when, it can be hard to know if you’ll have the cash in the bank when you need it, and it’s easy to miss a payment. Those late payment fees are just money down the drain. Having just one repayment to make can help you take back some control and help you avoid the risk associated with missed payments.

For an easier ride
A debt consolidation loan doesn’t mean you’re instantly on easy street – you still have to pay off the loan. It does, however, make your debt journey a little simpler. A debt consolidation loan works just like a personal loan. That is, you borrow a specific amount of money and then pay it back with interest over an agreed term. When and how much you pay is up to you. Decide on your loan amount, pay it over a set term with regular payments you can afford and breathe easy knowing you’ve got your debt covered.

For keeping more money in your pocket
Taking out a personal loan to consolidate credit card debt can be helpful if it means you pay less in fees. Debt consolidation loans generally allow you to enjoy a lower interest rate than you would receive with a credit card. They also offer a consistent repayment schedule. Manage your money right and you might even be able to make early repayments. All this good work adds up, helping save interest, pay down your debt faster, and getting you out of debt sooner.

Looking for a debt consolidation loan?

Find out how much you could borrow to consolidate your debts with a debt consolidation loan from Plenti.