Debt consolidation, is it a good idea?

Consolidating your debt is a good idea when the new loan costs less in total than the debts it replaces, and one repayment helps you stay on track. It's a bad idea when fees, a longer term or balances building back up leave you worse off than where you started.

We're not here to tell you that consolidation is right for you (for some people it clearly is, and for others keeping their current setup is the better move). So here we walk through the pros and cons of debt consolidation, the risks that are easiest to miss, and the situations where not consolidating is the right call.

What does consolidating your debt actually do?

It swaps several debts for one (it doesn't reduce what you owe on day one). A consolidation loan pays out your existing debts (credit cards, a personal loan, Afterpay or Zip balances) so you're left with one repayment, one rate and one end date. Whether that leaves you better off comes down to what the new loan costs against what your current debts cost, which is where the pros and cons below come in. (If you're still getting your head around the mechanics, start with what is debt consolidation and come back.)

What problem are you actually trying to solve?

Consolidation replaces several debts with one repayment, and that single change can fix two quite different problems. It helps to know which one you have before you weigh the pros and cons.

• Manageability. Several debts with different due dates and minimums are a load in themselves: moving money between accounts to keep direct debits funded, checking several apps just to see where you stand. One repayment on one date fixes that, whatever it costs.
• Cost. High rates, especially on credit cards, can mean repayments mostly service interest while balances barely move. Consolidation only fixes this when the new loan's rate, fees and term reduce the total you'll repay.

Plenty of people have both problems at once. The reason to separate them is that a consolidation loan can solve the first while quietly worsening the second, and the monthly repayment on its own won't tell you which is happening.

What are the pros of consolidating debt?

• One repayment instead of several. If you're paying off debts with different amounts on different due dates, one repayment on one date can make your week-to-week easier to manage, and there are fewer chances to miss a payment.
• A lower rate is possible. Credit cards often carry higher rates than personal loans, so moving card balances into a loan may mean paying less interest. However, the rate you're offered is priced to your credit position, so a lower rate is something to confirm before you commit rather than assume.
• A set end date. A card balance can roll on for years if you're paying the minimum. A loan has a term, so as long as you keep up the repayments, there's a date when the debt is gone.
• Headspace. Owing money across several accounts can feel like a weight you carry every day, and getting down to one repayment can take a lot of that weight off your mind.

What are the cons and the risks?

• Fees on both ends. The new loan can carry an establishment fee and monthly fees, and some existing loans charge exit or break fees when you pay them out early. The saving has to make sense after all of them (a car loan with a large payout fee, for example, can cost more to exit than the interest you'd save).
• The rate isn't automatically lower. The "from" rate in an ad is generally offered to applicants with the strongest credit profiles, and the rate you're offered may be higher. Put loans side by side on their "comparison rate" instead (it folds most fees into a single percentage, and it must be shown wherever a rate is advertised for this kind of loan).
• A longer term can cost you more. This is probably the easiest risk to miss, because a longer term makes the repayment look better. You're paying interest for longer, so the loan may cost more in total even at a lower rate.
• Balances can build back up. If the cards you consolidated stay open with cleared limits, spending on them again puts you back where you started, now with a loan as well. We've covered how to keep balances from building back up.

Below is the term risk with numbers on it, the same loan on two different terms:

Illustrative example at an assumed 12% rate. Not an offer, quote or advertised rate.

The 5-year loan frees up ~$30 a week, which may be exactly what your budget needs, however it costs ~$1,670 more overall. Both can be reasonable choices (some people are ok with paying more in total for a repayment they can comfortably manage), however that's a choice to make deliberately, with both totals in front of you. Running this comparison across your own debts has its own step-by-step guide: how much consolidation could cost or save.

[[calculator:break-even]]

Should you consolidate your debts?

Probably yes, if these four things are true (and worth pausing on if any of them aren't):

• the new loan's total cost (repayments plus fees, over the whole term) is lower than what your current debts will cost you, or close enough that one repayment and a set end date are worth it to you
• the repayment fits your budget on a term you chose deliberately, rather than the longest one on offer
• the loan clears the old debts completely, so you're not running a loan and card balances side by side
• whatever built the balances up has changed, so they don't build again alongside the loan

If those hold, the remaining question is which lenders would actually have you, and at what rate. You can answer a version of that before applying. WeMoney isn't a lender. It's a money management app with a matching service (BrightMatch) that shows you lenders from our panel whose criteria you may fit, before any application is made. You may qualify subject to the lender's own assessment.

Pro tip: BrightMatch uses soft checks only. No damage to your credit file, and no hard checks a lender can see.

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When not to consolidate your debt

If you're already unable to meet your repayments, a new loan is rarely the right first move. Your existing lenders have hardship teams whose job is to work out a change to your repayments with you, and the National Debt Helpline on 1800 007 007 is free, independent and confidential. The financial counsellors there do exactly this work, without selling you anything.

If your debts are small or nearly paid off, the fees on a new loan can be bigger than any interest saving, and it's completely fine to keep your current setup and pay it down directly.

And if the loans you'd realistically be offered carry a higher rate than you're paying now, or only work by stretching your debt over many more years, consolidating on those terms can leave you paying more for longer. That reflects your credit position at the time a lender assesses you rather than anything permanent. If your credit file is the reason, consolidating loans with bad credit covers the realistic options, and no legitimate lender guarantees approval (lenders can only lend where the loan isn't unsuitable for you).

A quick way to decide

Work through these in order, with your own numbers in front of you:

1. Can you cover essentials and minimum repayments? If rent, food, power or minimums are being missed, contact your providers' hardship teams and the National Debt Helpline (1800 007 007) before considering any new credit, and stop here until essentials are stable.
2. Is the pain concentrated in one expensive debt? If one loan carries the problem rate, look at refinancing that loan on its own rather than consolidating everything.
3. Are several debts expensive or hard to manage? This is where consolidation earns its keep. Model a loan against your debts with the term matched to your current payoff horizon, then see what a longer term does to the repayment and the total.
4. Is the balance mostly on credit cards, and could you clear it inside a promotional period? Compare a balance transfer against the consolidation scenario before deciding.
5. Are your debts affordable and on track? Pick a repayment order, add small extra repayments where you can, and skip consolidation on purpose.

One practical tip from members who've been through it: a repayment that lands just after payday, at your pay frequency, is easier to live with than the same total on a cadence that fights your budget.

Which consolidation option should you compare?

A personal loan is the most common route, however it's not the only one. Balance transfers suit card debts specifically, and homeowners sometimes roll debts into their mortgage. How the routes differ, and which problem each one actually solves, is covered in compare debt consolidation, balance transfers and personal loans.

When you're ready to look at actual loans, compare consolidation options on their comparison rates, fees, terms and total cost. And before you apply with any lender, the five checks in what to look for in a reputable debt consolidation lender take about five minutes.

Key points

• Debt consolidation swaps several debts for one repayment. It can cost you less in total, however it doesn't reduce what you owe on day one.
• The decision comes down to total cost after fees: the new loan over its whole term, against what your current debts will cost you.
• A longer term lowers the repayment and can still cost you thousands more in total, so choose the term deliberately.
• Don't consolidate when you can't meet your current repayments. Lender hardship teams and the National Debt Helpline (1800 007 007) come before any new loan.
• Cards left open with cleared limits are how balances build back after consolidating, so decide deliberately what happens to each old account.

This article is general information only. It doesn't take your circumstances into account.

Sources

• Moneysmart: Debt consolidation and refinancing
• Moneysmart: Personal loans
• Moneysmart: Financial counselling
• Moneysmart: Urgent help with money
• National Debt Helpline