Most of us have been in a situation where we want to buy something but we don’t have the money set aside for it.   When we are faced with this situation we have two choices.  The first choice is to delay the purchase.  ‘Thanks but no thanks’ I hear you say? The second choice is to borrow the money.  As you are no doubt aware, banks are in the business of lending money.  The interest rate on the loan is the price/cost of any loan.

Sometimes (especially when the loan amount is large) banks will use the asset that you are buying as security against the loan.   If, for what ever reason, you can no longer meet your loan repayments the bank can take possession of the asset, sell it and use the proceeds to repay the outstanding loan balance. If the bank has the ability to take possession of the asset and sell it to repay the loan then it goes without saying, that the risk to the bank of it not getting its money back is significantly reduced.

Banks taking security is very common when they lend for residential property purchases.   It’s very rare when it comes to credit card debt. That’s why the interest rate on a home loan is much lower than the interest rate on a credit card.

Ok, you’re probably wondering what any of this has got to do with consolidating your loans.  Well, I wanted you to understand what the cost of a loan is and why some loans are cheaper than others.

Should you consolidate your loans?

If you happen to have more than one loan it could make sense to consolidate them into  the cheapest loan.

How do you consolidate your loans? 

To consolidate your loans all you have to do is borrow more from your ‘cheapest’ loan and use the proceeds to repay the more expensive loan(s). [1]

An example

Say you have the following loans:

• $500,000 home loan at 7%
• $30,000 car loan at 12%
• $10,000 credit card at 19%.

The yearly interest bill on these three loans would equal $40,500.  That is, $35,000 on the home loan, $3,600 on the car loan and $1,900 on the credit card.

Consolidating your loans means increasing your home loan to $540,000 and using $30,000 to repay the car loan and $10,000 to repay the credit card. After consolidation your loans would look like this:

• $540,000 home loan at 7%
• Nil car loan at 12%
• Nil credit card at 19%.

If you consolidate, your yearly interest bill is reduced to $37,800.  This is a reduction of $2,700 in one year alone!  If you then choose to put the additional $2,700 onto your home loan you will repay your home loan years sooner.

An added benefit of consolidating loans is that you only have one loan repayment instead  of multiple loan repayments.

Please be aware, before you go ahead and consolidate loans, it is important to see if there are any costs in paying out the more expensive loans early.

If you would like to discuss the possibility of consolidating your debts, please feel free to contact me on 03 9375 5100.