Some financial institutions promote refinancing your loan and consolidating your debts as ways to make your debts more manageable. However, if you’re in financial hardship, you need to read the fine print if you are considering these options. You may, in fact, end up paying more under the changed arrangements than you would have in your original loans.
Refinancing involves cancelling your current loan agreement and entering into a new loan agreement with your current lender or another lender. Debt consolidation usually means getting a new loan or varying an existing loan to pay out a number of other loans.
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The effects of refinancing or consolidating debts
Most people refinance or consolidate debts in an attempt to make their loan repayments more affordable in the short-term. However, the cost of your new loan (including interest, fees and costs) must be significantly lower than what you have been paying for this to be an effective debt management strategy.
Bear in mind that if you have recently lost your job or experienced reduced income it is unlikely that a lender would be offering you a less-expensive loan.
If you consolidate loans, you may end up with fewer debt payment options if your difficulty is ongoing. For instance, you will not be able to negotiate payment plans for individual debts and you may not be able to access specific hardship programs. Your loan may also then exceed the threshold and you would lose the right to seek hardship variation in court. For loan contracts entered into before July 1 2010, a floating threshold applies ($356,040 for the period July 12 2010 - August 9 2010). Where you entered your loan contract after July 1 2010 the threshold is $500,000.
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The benefits of refinancing or consolidating debts?
People usually consolidate debts to:
- reduce monthly payments;
- manage a single debt instead of several debts, all with different conditions, terms and payment dates;
- save money when the interest and costs are lower overall than the interest and costs of the old loan arrangements.
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The disadvantages of refinancing or consolidating debts?
Refinancing or consolidating debts may seem attractive options in the short-term. However, they may have disadvantages when viewed over the term of your loan including:
- you may have to pay exit fees to get out of existing loans early.
- the fees and charges of setting up and maintaining your new loan may be more expensive than if you had kept your existing loan/s.
- if you change your unsecured debt into a debt secured over your home, your equity in your home will be reduced and you’ll be paying off the debt for a longer time, making it more expensive.
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How to compare loans
You need to check the costs of your current loan against its cancellation cost plus the set-up and ongoing costs of any new loan before you decide to refinance or consolidate your debts.
You should consider:
- interest rates
- if the loan has fixed or variable interest
- all fees and charges for the life of the loan
- monthly payments over the life of the loan
- applicable exit fees
- any other available options to reduce your debt
- any security required under the loan agreements
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Using your mortgage to refinance or consolidate debts
If you are ahead with your mortgage payments, you may be able to re-draw against the mortgage to pay out loans with a higher interest rate.
It may be less costly to transfer all of your other debts to your mortgage account and extend its term than it would be to refinance into a whole new loan. Many home loans can be extended in this way, and a changed mortgage payment plan negotiated.
In the longer term, you may be able to fast-track paying off the extra debt when you get your finances under greater control. This way you can reduce the overall costs of the loan. You might also increase your loan repayments by as much as you can afford, or if you find yourself with extra money, make a special loan repayment.
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Some traps of refinancing or consolidating debt
It’s a good idea to seek independent advice regarding your options before making a decision if you are considering these debt options
Some unscrupulous lenders offer loans on very unfair terms, particularly if they think you are in financial difficulty. They may also charge you higher interest if they regard you as a higher risk or you have a record of past payment defaults. And you might end up in a worse financial position, especially if your house is security for a new or consolidated loan.
Some lenders offer to refinance on “interest-only” terms for one or two years. Under these arrangements, you’ll have an equivalent level of debt at the end of your loan despite making all required payments. You will have essentially been standing still financially. You may also have to find a new loan in what may be a more difficult lending market.