Debt consolidation: how it works, and when it stacks up

Rolling a few debts into one repayment is one of those ideas that always looks good on the monthly figure. Whether it saves you money depends on the total cost over the full term, which is the number nobody puts on the brochure.

It is worth separating two different reasons for doing it. One is to pay less interest. The other is to make the month survivable by having a single date, a single amount and no juggling. Both are legitimate. They are not the same thing, and a consolidation that does the second brilliantly can quietly fail at the first. Decide which one you are actually buying before you sign anything.

What debt consolidation actually is

It's taking out one new loan, using it to pay off several existing debts, and then only having that one loan left to manage. Instead of three or four repayments hitting your account on different days at different rates, you've got one repayment, one due date, one interest rate.

The new loan is an ordinary credit product. Consolidation loans for personal debt are generally regulated by the National Credit Code, which means the lender has to make reasonable enquiries about your situation and assess whether the loan is not unsuitable for you before approving it. That obligation is why you get asked for so much paperwork.

What can usually be rolled in

Credit cards, store cards, existing personal loans, some buy-now-pay-later balances, and sometimes an overdraft. What gets included depends on the lender and on whether each debt can be paid out cleanly. Tax debts, fines, and anything already with a collection agency are usually handled separately. Raise those up front rather than hoping they go unnoticed.

The monthly number is not the answer

Stretch a two year card balance across a five year loan and the repayment drops. So does the rate, probably. You can still pay more in total, because you are paying interest for longer. Compare total cost to total cost or you are comparing nothing.

How to work out the number that matters

Total cost is the repayment multiplied by the number of repayments, plus any fees to set the loan up and any fees to close the old ones. Do that for what you have now and do it again for what is proposed. One of those two numbers is bigger, and it is not always the one you expect.

Here is an illustration. The figures are invented and rounded to keep the arithmetic visible, and they are not a market rate. Say you owe twenty thousand dollars across a few accounts and you are currently paying eight hundred dollars a month, with the debts clearing in a bit under three years. A consolidation loan offers you four hundred dollars a month over five years. The monthly saving is four hundred dollars, which feels decisive. But eight hundred a month for thirty months is twenty four thousand, and four hundred a month for sixty months is twenty four thousand as well, before you add the fees to set the new loan up. The relief is real. The saving is not.

Run the same illustration with a shorter term and the picture changes again. Take that consolidation over three years instead of five and the repayment sits higher, but the total drops. This is why the term is the lever that matters most, and why the sales conversation is almost always about the monthly figure instead.

Count the cost of getting out

Existing loans can carry early payout fees, and fixed rate contracts can carry break costs. Those come off the top of whatever you are saving. Sometimes they wipe it out entirely, which is a perfectly good reason to leave a loan exactly where it is.

Ask each existing lender for a payout figure in writing rather than reading the balance off an app. A payout figure includes interest to the settlement date and any fees to discharge the loan, and on a secured loan there may be a further fee to remove the lender's interest from the register. On the new side there is usually an establishment fee, and possibly an ongoing monthly fee. Put every one of those in the sum. They are the difference between a consolidation that works and one that only looked like it did.

Secured beats unsecured on rate, at a cost

Consolidating into a secured loan is usually cheaper, because there is an asset sitting behind it. It also means debt that was unsecured has quietly become secured. Worth understanding before you sign rather than after.

Spell out what that means in practice. A credit card balance is unpleasant if it goes bad, but the card company cannot take your car. Roll that balance into a loan secured by the car and the position has changed. The same logic applies, at much larger scale, to folding consumer debt into a home loan: the rate is lower, the term is far longer, and the security is the roof over your head. A small debt spread across a twenty five year mortgage can cost more in interest than it ever would have on the card, even at a much lower rate, and the consequences of falling behind are of a different order.

It only works once

The trap is clearing the cards and then using them again, so you finish up with the consolidation loan AND the cards. If the cards are staying open, be honest with yourself about that first.

Should the cards be closed or just paid off?

Paying a card to zero does not remove it. The limit is still there, and lenders assess you on the limit rather than the balance, because you can draw it again tomorrow. That affects what you can borrow next time, whether the account is used or not.

Closing accounts as part of the consolidation is often a condition of the loan for exactly this reason, and some lenders will pay the balances directly to the card providers rather than depositing the funds to you. That is not distrust. It is the only version of the arrangement that reliably ends with the debt gone.

What it does to your credit file

A consolidation puts an enquiry on your file and opens a new account, and closes several others. In the short term that is a visible change rather than an improvement. What improves it over the following months is the thing you do next: making every repayment on the new loan on time.

Under comprehensive credit reporting, repayment history sits on your file for existing credit accounts, so a clean run on a consolidation loan is doing useful work in the background. What consolidating does not do is erase anything. Defaults, missed payments and past enquiries stay where they are for their own periods regardless of whether the underlying account has been paid out.

When it does stack up

• Several high rate balances, especially store cards and revolving credit
• A clean payment history, so the new loan prices well
• Exit costs on the old debts that are small next to the interest saved
• A term that is not much longer than what you are already on
• A firm intention to close the accounts you are paying out, not just zero them
• Income that comfortably covers the new repayment with something left over

When it does not

If the existing loans are close to finishing, the interest you have left to pay is small and the fees to refinance may well exceed it. If your credit file has taken recent damage, the new loan will price accordingly, and swapping several moderate rates for one poor one achieves nothing. If the real problem is that the money is not there each month, consolidating does not fix that. It reschedules it, and it buys time that only helps if something else changes as well.

And if you are consolidating mainly to free the cards up for use again, the maths has already been decided. You will end up carrying both.

Worth pricing before you consolidate

Consolidation is one option, not the only one. A balance transfer can move a card balance to a lower or interest free rate for a set period, which works well if the balance genuinely clears inside that period and badly if it does not, because the revert rate is usually high. Paying the highest rate balance down hard while maintaining minimums on the rest costs nothing to set up and is often quicker than people assume. If you are behind or about to be, lenders in Australia have hardship provisions and are obliged to consider a hardship request, which can mean a temporary reduction or pause without a new loan at all.

Free financial counselling is also available in Australia, including through the National Debt Helpline, and it costs nothing to use. If the debt has become genuinely unmanageable, that conversation is a better first step than another credit application.

What a lender looks at on a consolidation application

Blunt version: they want to see that the new repayment fits your income after everything else you pay, and that the debts you say you are clearing will actually be cleared.

• Your income, its type, and how long you have been earning it. Payslips, or tax returns and recent BAS if you work for yourself
• Bank statements, usually the last few months, read line by line
• Every existing debt: the lender, the limit, the current balance and the repayment
• Your credit file, including repayment history and recent enquiries
• Your living expenses, and whether the figure you declare matches your statements
• Dependants and other household commitments
• Whether the old accounts will be closed or reduced once they are paid out

A serviceability buffer usually applies as well. The lender assesses the repayment at a rate above the one you are being offered, to check the loan still fits if rates move. That is often why an approval comes back lower than the arithmetic in your head suggested.

What to have ready

If you do want it compared properly, the working out needs real numbers rather than estimates. Have these together.

• A written payout figure for each existing debt, not the app balance
• The rate, the current repayment and the remaining term on each one
• Any early payout or break costs quoted by the existing lenders
• Credit card and buy now pay later limits as well as balances
• Recent payslips, or tax returns and financials if you are self employed
• Bank statements covering the last few months
• A realistic set of living expenses, because these get checked against the statements
• A copy of your own credit report, so there are no surprises in the assessment

The short version

A consolidation is worth doing when the total cost falls and the accounts behind it close for good. It is worth skipping when the saving only exists on the monthly line, when the exit costs eat it, or when unsecured debt is being quietly attached to an asset you cannot afford to lose. The term is the lever. Look there first.

We will run it both ways and tell you straight when it does not stack up. More on debt consolidation and refinancing.