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What is Debt Consolidation?

What is Debt Consolidation?

Struggling to pay off more than one debt at a time? Debt consolidation could be for you. Continue reading for a deeper understanding.

30th June 2020
Reading Time: 2 minutes

What is debt?

Debt is money that is due for the payment of something. If debt isn’t managed effectively, it can easily get out of control. Debt can be personal such as credit cards, mortgages or student and tax debt. Failure to pay off a debt can lead to the individual’s assets being seized or sold and bankruptcy being declared. Debt can also be present in a business or company such as business loans. If a business is unable to pay back its debts it becomes insolvent. Debt consolidation is often used to prevent this.

What is debt consolidation?

Debt consolidation requires bringing all your current debts together into one new debt. This is done by taking out a new loan to pay off the collected of debt. This helps manage your repayments. It is important to understand that debt consolidation loans do not erase the original debt but rather transfer the loans. Multiple debts are combined into a single, larger piece of debt with a favourable interest rate and lower monthly payment. Consumers can use debt consolidation to deal with credit card debt, student loans and other liabilities. It is similar to debt financing

How does it work?

When an individual decides to consolidate their debt they apply for a loan. This loan is the single liability which represents the culmination of all their debts. Most individuals apply for a debt consolidation loan through their bank or credit union, this is a great place to start.  If you do not receive a new loan from your bank you can try other specialised debt consolidation services. However, if you are successful with receiving a new loan you will be required to make payments until the new debt is paid off in full.

Types of Debt Consolidation

There are two main types of debt consolidation loans. These are secured and unsecured loans. Secured loans are a loan backed by an asset such as the borrower’s house or a car. The asset can be sold to get the money back if they are unable to repay the loan. The asset is described as collateral for the loan.

Unsecured loans, on the other hand, are a loan for which no asset has been used as security. This makes them more difficult to obtain. They tend to have higher interest rates as there is a higher risk of the lender not getting their money back.

Key considerations

Advantages

  • A consolidated debt will allow for a potentially better and lower interest rate then the current interest rates you have.
  • Your repayments are easier to manage.
  • You do not have multiple annual fees.
  • It provides you with a clear timeline outlining when you’ll be debt-free. This can be beneficial for when you are budgeting. You will be able to spend less time trying to figure out all the maths and more time focusing on your budgets.
  • By consolidated your debt you may be able to avoid bankruptcy by stopping your debt from getting out of your control.

Disadvantages

  • Possibility of creating more debt when you receive more credit, as you may be tempted to spend more.
  • You may experience a longer pay schedule leading you to, in the long run, ultimately be paying more.
  • You may be charged with an early exit fee from your current loans or a starter fee from your new consolidated debt loan. This increases the overall amount you will have to pay. You have to consider whether you would have paid less if you did not consolidate your debts.

If you have any further questions feel free to contact a lawyer today. 

Don’t know where to start?
Contact a Lawpath consultant on 1800 529 728 to learn more about customising legal documents and obtaining a fixed-fee quote from Australia’s largest legal marketplace.

Author
Liesel Millard

Liesel is a legal tech intern at Lawpath, working as part of the Content Team. She is currently in her second year of a combined Bachelor of Business and Bachelor of Laws degree at the University of Technology Sydney. She is interested in areas of sports, corporate and intellectual property law.