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Debt consolidation can help you in tough times |
In the current economic environment where people are concerned about their job security and often their high level of debt, then one option to immediately consider is debt consolidation. If you are in a secure job and managing your debt well then there is no need to consider debt consolidation because over the long term it often result in your paying more interest. Why is this? Basically, people wanting to look at debt consolidation are mainly driven by the need to improve their cash flow. One way of achieving this is through debt consolidation. The aim of debt consolidation is to reduce your overall interest rate on your total debts – these might include a mortgage, car lease, personal loan or credit cards. Of these loans the cheapest rate applicable will be the interest rate you are paying on your home loan because there is less risk associated with a mortgage as it is secured by property. On the other hand your credit card debt is unsecured and if you were to default on repayments it is not always easy for the banks to recover their money. So…you will always pay a higher rate of interest on unsecured debt. As at November 2008 home loan rates ranged from 6.99 to 7.50% variable while credit card rates are as high as 20.74% in some instances.
e.g $100,000 @ home loan mortgage interest rate of 6.99% p.a. = $6,999 p.a
$20,000 @ credit card interest rate of 19.75% p.a = $3,950 p.a.
TOTAL INTEREST = $10,949 p.a
Your monthly outgoing before debt consolidation = $912
Through debt consolidation you combine your personal loans and credit card balances into your home loan mortgage so that you are paying the lowest interest rate possible on all you debts. Through such a debt consolidation exercise you then reduce the overall monthly outgoing and thereby improve your cash flow. e.g. $120,000 @ home + $20,000 credit card @ 6.99% p.a. = $8388 p.a Your monthly outgoing after debt consolidation = $699 The monthly saving after debt consolidation is $213. What you need to remember however is that while you are paying a lower monthly repayment, you will be paying this amount for a longer time. Most personal loans and credit card debt require either a minimum payment over a period of time e.g. a personal loan will most likely be for a maximum term of 10 years. On the other hand, home loans are generally for 25 or even 30 years. So, before debt consolidation your monthly payment is calculated to repay the loan in 10 years whereas after debt consolidation your monthly repayment is calculated so you repay the $20,000 over a 25 years term. It is important to realise that when you decide on a debt consolidation path you acknowledge that you will repay more interest over the longer term but that this is better that losing your home property or going into bankruptcy because you simply do not have the cash flow you need to prevent defaulting on the debts. Once you have undertaken the debt consolidation then you get relief from those higher payments and hopefully are able to better manage your cash flow. If at any stage your financial situation further improves then even though you have gone through the debt consolidation process you can always start making extra repayments on your loans. |
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