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Is Debt Consolidation Really The Best Option?

February 27, 2018

Borrowers often want to repay or consolidate their short-term debts by increasing their mortgage finance. In theory, this sounds like a great idea. You get to roll all your debts into one loan / payment / facility, most likely reduce the interest rate charged and maybe even reduce your minimum instalments, which will have a positive effect on your cashflow. However, there are also pitfalls that borrowers may be unaware of when it comes to debt consolidation.

 

Increasing your mortgage debt to refinance or consolidate short-term debt can often result in a lower interest rate, which in turn can save you money. However, if the new loan is set to a longer loan term you might find yourself paying for whatever was purchased initially (which could be cars, travel or other devaluing assets) over 25 or 30 years, rather than the shorter terms usually applied to personal loans. This could end up costing you a lot more over time. We recommend that borrowers set the loan term to a similar period of time to the debt being refinanced. The benefit is there in the form of the lower interest rate, and, therefore, lower loan instalments. And you won’t end up paying for say, a vehicle, long after it has outlived its use.

 

If you are refinancing credit card debt, the credit card account should be closed at the time of the refinance. If the account isn’t closed, and if you haven’t changed your behaviour towards your finances, you could find that the credit cards get gradually drawn back up to the amount that was refinanced, meaning you could end up with twice as much debt as you originally had (i.e. the amount that was refinanced and the additional amount drawn to on the credit cards). Believe me, I have been around long enough to know that this is not an unusual occurrence.

 

Whether you decide to consolidate your debt or not, taking time to assess your finances and make a realistic budget can lead to an improved understanding of your finances and better cashflow management.

 

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