Depending on your financial situation, there are several types of home loans that can cater to your wants and needs.
A debt consolidation home loan is one that may offer some financial relief and help save you money on interest, especially if you are struggling to pay your mortgage.
In this article, we discuss what debt consolidation is, how it works and the benefits and drawbacks. We also highlight important things to consider before you consolidate your debt.
What is a debt consolidation home loan?
Debt consolidation is the act of bundling multiple debts into a single loan during the refinancing process. A debt consolidation home loan allows you to combine your debts into a lower-interest home loan so you can make one combined monthly repayment from one debt account.
What types of debt can you consolidate into your home loan?
By consolidating these debts with your home loan, you could repay your debt at a lower interest rate.
The most common types of debt consolidated include:
Credit cards, store cards or ‘buy now pay later’ debt: These cards come with notoriously high interest rates and with no set repayment term meaning you might never pay it off
Personal loans: These loans generally come with high interest rates and a set time to be paid back
Car loans: These loans usually need to be repaid over a period of 1-5 years and can also be consolidated into your home loan
Other credit accounts: Some lenders give you the option to process more private credit accounts like utility bills for electricity, phones and TV. However, not all debt consolidation loans have these features so it’s best to check with your lender first
You might be interested in: Benefits of consolidating personal debt
What are the benefits of debt consolidation?
Enjoy lower interest rates: home loans typically have much lower interest rates than unsecured debt. By consolidating your debt into your home loan, you pay less interest over a longer repayment period
Manage your debts in one place: you’ll be able to streamline your debts into a single, easy-to-manage debt account and make one monthly repayment
Avoid multiple account fees: because your debt has been combined into one account, you can avoid the fees that usually come with having multiple open accounts
Improved cash flow: because you’re paying your debt at a lower interest rate, you’ll free up additional cash flow to spend, save or invest
What are the potential drawbacks of debt consolidation?
Your home is at risk if you don’t make your repayments: when you consolidate debt, you convert unsecured debt into secured debt (where you offer an asset as security). This means your property will be at risk if you default on your repayments
You can potentially pay more interest over time: if your debt consolidation loan is poorly structured, there’s a chance you could pay more interest over the life of your loan. It’s a good idea to think about the length of the repayment period for your consolidated debt
Refinancing fees: you may be charged standard refinancing fees, including setup, exit and application fees
You could increase your Loan to Value Ratio (LVR): by bundling your existing debt with your home loan, you could negatively impact your LVR. If your LVR goes above 80%, you may be charged Lenders Mortgage Insurance (LMI)
Less flexibility: many loans for unsecured debts allow you to make repayments as frequently as you’d like. Depending on the type of home loan you have, you may be limited to only monthly repayments and may be charged if you make extra repayments
How does debt consolidation work?
Consolidating your debt into your home loan requires you to refinance your home loan. Think about whether debt consolidation will strengthen or harm your financial situation before you take the next step.
1. Check your eligibility
Get in touch with your broker to discover if you’re eligible to refinance on a debt consolidation loan. You’ll need to check if you have sufficient equity in your property to cover the increased debt. This is usually done through a valuation conducted by the bank.
2. Provide documentation
You’ll also need to provide certain personal and financial documents to your lender, so they can better assess your situation. These may include:
ID verification documents (drivers licence, birth certificate, passport)
Home loan repayment statements
Recent payslips
Tax returns
Group certificate/PAYG summary
Loan statements for your existing debts
3. Show your reliability as a borrower
You’ll need to demonstrate to your lender that you are a savvy saver and responsible borrower who will be able to make the increased mortgage payments on time. You may be asked to provide:
Proof you can make regular monthly repayments on time
Letter of employment
Proof of income
Recent bank statements
Can you consolidate debt if you have a bad credit score?
A bad credit score and credit history may cause some difficulties in obtaining a debt consolidation home loan. This is because lenders won’t typically lend to borrowers they deem ‘high risk’.
Some lenders will provide loans to those with lower credit ratings, but these usually come with higher interest rates and loan establishment fees.
There are several things you can do to help boost your credit score and give you the best chance of securing a fair deal:
Review your bad credit: Firstly, you need to know the extent of your bad credit rating. You can obtain a copy of your credit report from any credit report agency for free. You should also be checking your credit score and report any instances of inaccuracies.
Pay your existing debts on time: You may not be eligible for a consolidation loan now due to your credit history, but if you spend six months making sure that you pay every loan repayment and utility bill and debt on time, your chances are likely to improve significantly. Your should also ensure you cancel any credit cards you are no longer using.
Don’t apply for multiple of loans at once: Remember not to over apply to lenders as too many credit checks over a six month period of time can negatively impact your credit score. Lenders may suspect that you have been declined for other loans and view you as a risky borrower.
Review your debt position: Once you’re aware of your credit history, make a list of the personal debts you would like to consolidate into your home loan. Separate unsecured and secured loans from each other and check if they have penalty fees. Contact your existing lender to assist you and obtain a written copy if possible.
When can I consolidate debt?
Some lenders can make you wait up to 6 months from taking your home loan out before you can increase it. However, depending on the reason, the majority of lenders are now open to it straight away, depending on the strength of the application and purpose of the funds.
Things to consider before consolidating your debt
1. Is it the right option for you?
Debt consolidation can be a great way to bundle your existing debts into one easier to manage debt account and a single monthly repayment.
However, your financial situation and individual needs are important to consider. Will consolidating your debt allow you to better manage your finances? Or will it tempt you to take out additional loans you don’t need?
2. Weigh the potential savings and costs involved
Although consolidating your debt can save you in interest if your loan is structured correctly, there are additional costs to think about.
When you refinance to a debt consolidation loan, you may be charged standard refinancing fees, loan establishment fees and (if your LVR surpasses 80%) LMI.
It may be a good idea to make some calculations and work out if the savings outweigh the costs. You can do this by listing repayment amounts for each of your loans, the fees and charges associated with refinancing and comparing respective interest rates.
You can ask your lender to provide a list of potential refinancing fees to help with your calculations.
3. Structuring your loan wisely
To limit the risk of paying more interest than you need to, select a shorter time frame to repay your consolidated debt.
For example, if you have 10 years remaining on your home loan repayment term, you could choose to repay your consolidated debt within a 4 year period instead.
4. Compare lenders and loan products
It’s important to find a home loan product with a competitive rate that will work for you, so you can put yourself in the best financial position to pay off your debts.
Don’t be afraid to branch out and compare offers from different lenders. If you aren’t open to switching lenders, there’s a chance you could be missing out on a better deal.
5. Get expert advice
It’s a great idea to speak to a broker or home loan specialist for advice. They will be able to assess your needs and make recommendations that will benefit your financial situation.
They’ll also be able to find out how much you can borrow should you decide to refinance to a debt consolidation home loan.
If you’re thinking about debt consolidation, our Aussie Brokers can help. Simply book a time to chat with an Aussie broker and we’ll get in touch at a time that works for you.
