Consolidating debt could save a bundle but there are risks

By By Nick Gardner, From: News Limited newspapers, 4 May 2010

FOR borrowers struggling with a range of debts such as credit cards, personal loans, car loans and store cards, consolidating them into a mortgage could save a fortune.

With interest rates on store cards as high as 30 per cent, credit cards at 15-20 per cent and personal loans averaging about 10 per cent, it seems obvious that refinancing these debts on to a mortgage rate of, say, 7 per cent, can save you a considerable amount of money.

And there's never been a more important time to do it, with interest rates on the rise and forecast to keep rising for another year or more.

Even Reserve Bank Governor Glenn Stevens says we are entering an age in which "some households would seek to contain and consolidate their debt'' instead of continuing to borrow, as interest rate rises begin to bite.

Recent data shows he is right.

The statistics

Credit information agency Veda Advantage's latest Galaxy survey shows 64 per cent of people plan to reduce credit card debt in the coming six months, with almost half planning to pay the full amount.

"Households are becoming more conservative,'' Veda Advantage head of external relations Chris Gration says.

"Demand for all types of credit is falling as people take a more prudent view of their financial situation.''

However, Veda's statistics also uncovered 19 per cent of people are "severely stressed'', by which they mean they are struggling to make their next debt repayment, or "don't know how they were going to make it at all''.

For some of these stressed borrowers, debt consolidation could be the answer, helping to free up valuable cashflow.

How it works

Consolidation of debt works where a borrower has a range of high-interest debts, such as credit cards and store cards or even car loans, and wants to lump them together into one tidy repayment.

The idea is to consolidate all the debts into one loan with a lower interest rate to maximise the savings and the lowest rate tends to come with your mortgage.

But it needs to be approached with caution. It all depends on how you behave once you've consolidated that debt. It could be a stroke of genius, or it could be the worst thing you've done.

Nicole Rich of the Consumer Action Law Centre says a major issue with the industry is misleading marketing.

"Firstly, people usually approach companies about debt consolidation after seeing some kind of marketing about it and the problem is a lot of that can be very misleading,'' she says.

"What a lot of companies do is instead of offering people consolidation loans, they actually negotiate a Part IX debt agreement, which is an alternative to bankruptcy where you pay your creditors a smaller amount each month.

That then stays on your credit record for seven years with obvious consequences if you want to get credit again.''

Another problem is that some borrowers take out consolidation loans that they can't afford, sometimes with interest rates that are higher than their debts but sold under the premise of ``convenience'' instead of lower cost, Ms Rich says.

"If there is a big saving compared with your current outgoings, it might be an option'' she says.

"But if you're in genuine hardship, you should contact your creditors where you should be able to negotiate lower repayments anyway, which is a better option than getting another loan, especially if it means lumping them in with your mortgage, which could ultimately put your home at risk.''

Rules are changing

Hardship arrangements work well right now but from next year when the Government brings in new laws called "comprehensive reporting'' for credit reference purposes, any hardship arrangements will start showing up on your payment history and will count against you for future credit applications.

Katherine Lane, principal solicitor of the Consumer Credit Legal Centre in New South Wales, says while consolidation loans may serve a purpose for some, they are not the answer.

"Any action you take on consolidating loans has to be matched with a change in behaviour: Cut up credit cards, don't take another personal loan and live within your means.