Personal loans for debt consolidation

TAMIKA SEETO
Finance Journalist · 7 December 2020
If you are juggling multiple debts, one option is to combine them into a single personal loan.

A debt consolidation loan could make it easier for you to manage your repayments. However, it’s important to tread carefully and make sure the new loan doesn’t end up costing you more in interest and fees.

What is a debt consolidation loan?

A debt consolidation loan combines some or all of your existing debts (including credit card debt and other loan products) into one personal loan. The aim is generally to make it easier to manage your repayments. If you take out a personal loan with a lower interest rate than what you’re paying on your existing products, this could also help to reduce your overall debt.

Are debt consolidation loans a good idea?

A debt consolidation loan can have several possible benefits, such as:

  • You only have to make one regular repayment, which may make your debt easier to manage.
  • You may be able to save on interest charges by getting a personal loan with a lower interest rate than your existing debts.
  • Personal loans are repaid over a fixed term, so you have a clear timeline for when you can be debt-free (provided you make your repayments and pay any additional fees on time).

However, if the loan is more expensive than your existing debts, then you could end up accumulating more debt through interest and fees. It’s important to compare the interest rate and fees of any new loan you’re considering against your current debts. You should also look at the term of the new loan and work out how much you would end up paying over the life of the loan. Generally, the longer the term, the lower your regular repayments would be, but the more you would pay in total.

If you are finding it difficult to manage your credit card repayments or other debt, you can also contact your lender or credit card provider to see what your options are. You might also want to seek advice from a financial counsellor. Financial counsellors offer free, independent and confidential advice. You can speak to one through the National Debt Helpline on 1800 007 007.

Compare debt consolidation loans

It’s a good idea to compare debt consolidation loans before choosing one as the cost can vary significantly depending on the provider. To give you an idea of cost, Canstar has analysed the interest rates and fees for the average unsecured personal loan awarded a 5-Star Rating compared with Canstar’s database average:

5-Star Rated product average Database average Difference
Interest rate 7.56% 11.82% 4.26%
Upfront fee* $121 $207 $86
Ongoing annual fee* $5 $33 $28
Source: www.canstar.com.au – 03/12/2020. Based on products rated in the Unsecured Personal Loan profile of the Canstar Personal Loan Star Ratings (October 2020). Average interest rate calculations use the midpoint of the rate range, where applicable. Total cost includes total interest paid plus the applicable fee/s, which are assumed to be paid separately and not added to the loan balance. *Average calculations for fees based on all applicable products, including those that don’t charge a fee.

As you can see, the average interest rate was lower on a 5-Star Rated personal loan. Where lenders charged upfront and ongoing fees, these were also lower, on average.

Eligibility for a personal loan – and access to the best loan terms a lender has to offer – may be subject to your credit score and other financial circumstances. For example, if you have a low credit score, some lenders may charge you a higher interest rate compared to someone with a good credit score. If your score is not as high as you would like, there are steps you can take to help improve it.

If you are looking to compare personal loans, the following table shows a selection of loans from various providers on our database that offer unsecured personal loans (meaning they do not require an asset as security). Before applying, confirm with the provider whether the loan can in fact be used for debt consolidation purposes.

The table below displays some of our referral partners’ unsecured personal loan products for a three-year loan amount of $20,000 in NSW. The products are sorted by Star Rating (highest to lowest) followed by comparison rate (lowest to highest). Use Canstar’s personal loan comparison selector to view a wider range of products on Canstar’s database. Canstar may earn a fee for referrals. Read the Comparison Rate Warning.

How does a debt consolidation loan compare to a credit card?

The difference between paying off multiple credit cards with debt or one personal loan can be significant. For example, some people only pay the minimum repayments on credit cards in order to avoid late payment fees. This may mean they fall into a cycle of paying interest on the remaining balance, while not making much ground on paying down the amount owed.

This is compared to a personal loan, where the required repayments cover the principal amount plus interest, and there is a fixed date for when you will have the debt paid off if you keep up with those regular repayments.

Canstar’s Research team has put together a hypothetical example to show what the difference in cost could be, based on average figures from our database. In this example, you are paying off two credit cards. The first is a low-rate credit card with an outstanding balance of $10,000, an interest rate of 11.99% and an annual fee of $46, while the second is a rewards credit card with an outstanding balance of $5,000, an interest rate of 19.80% and an annual fee of $183.

If you chose to pay the minimum repayment of 2% or $20 (whichever is higher) across both cards, your repayments would look like this:

Credit cards – $15,000 balance split across two cards
Low Rate Rewards
Amount owing $10,000 $5,000
Interest rate 11.99% 19.80%
Annual fee $46 $183
Minimum repayment – month 1 $202 $102
Time to repay 24 years, 7 months 43 years, 10 months
Total interest $9,202 $18,358
Total fees $1,104 $7,869
Total interest & fees $10,306 $26,227
Source: www.canstar.com.au – 03/12/2020. Rate for the low rate card assumes an approximate average for unsecured personal credit cards that do not have rewards and were rated in the Low Rate profile of Canstar’s Credit Card Star Ratings (October 2020). Annual fee for the low rate card is based on the average annual fee for unsecured personal non-rewards cards rated. Rate and annual fee for the rewards card is based on unsecured personal rewards credit cards in Canstar’s database. Annual fee is assumed to be paid separately and not added to the credit card balance. Minimum repayment is assumed to be $20 or 2%, whichever is higher, across both low rate and rewards cards.

The minimum repayments on your credit card will generally decrease over time, assuming you do not use the credit cards for additional purchases.

In this hypothetical example, you decide to consolidate your combined $15,000 credit card debt into a $15,000 unsecured personal loan. Here, we have looked at what your repayments might be if you took out the average 5-Star Rated personal loan repaid over three years. Bear in mind that to be eligible for these loans, you may need to have a good credit score.

5-Star Rated personal loan – $15,000 paid off over 3 years
Interest rate 7.56%
Upfront fee* $121
Ongoing annual fee* $5
Monthly repayment $467
Total interest $1,812
Total interest & upfront fee $1,933
Total interest & upfront & ongoing fees $1,948
Source: www.canstar.com.au – 03/12/2020. Based on products rated in the Unsecured Personal Loan profile of the Canstar Personal Loan Star Ratings (October 2020). Average interest rate calculations use the midpoint of the rate range, where applicable. Total cost includes total interest paid plus the applicable fee(s), which are assumed to be paid separately and not added to the loan balance. *Average calculations for fees based on all applicable products, including those that don’t charge a fee.

It’s important to make sure you can afford the new repayments on the debt consolidation loan. In the hypothetical example above, your monthly repayments would be higher on the personal loan compared to the two credit cards. You may be able to lower your repayments by choosing a personal loan with a longer term, however it’s important to calculate how much you would pay in interest and fees over the life of the loan and to compare this with your existing debts.

If you are able to make your monthly repayments on the personal loan, you may be able to save a significant amount in interest and fees. You would also be able to pay off your debt over a set period of time.

How could a debt consolidation loan affect my credit score?

A debt consolidation loan itself generally shouldn’t affect your credit score any more than any other type of personal loan.  That said, when you apply for credit – including a credit card or any type of personal loan – it is noted on your credit report as a credit enquiry.  If you make multiple applications in a short period of time, this could negatively impact your credit score, making it difficult to obtain credit in the future.

Additionally, if you don’t meet your repayments on the loan, this will generally be recorded on your credit report and may lower your credit score. In contrast, if you make your repayments on time and demonstrate a good repayment history, this would also be noted on your report and could actually improve your credit score.

Therefore, you should carefully consider your financial position before applying for this type of loan, as well as checking to ensure the loan as a whole suits your needs.

→ You can check your credit score for free

If you are finding it hard to manage your debts, you can contact a financial counsellor for help. Call the National Debt Helpline on 1800 007 007 to speak to a counsellor for free.

Cover image source: sixninepixels (Shutterstock)

Original authors: Shay Waraker and Ellie McLachlan. This article was reviewed by our Sub Editor Tom Letts and Finance Editor Sean Callery before it was updated, as part of our fact-checking process.

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