Don’t make this one debt consolidation mistake
Debt reconsolidation is a popular choice for people who have too many debts. Debt consolidation can:
- Simplify your repayments.
- Reduce how much interest you pay.
- Make your repayments more manageable.
- Restructure your loan with more favourable terms.
Sounds great, right? But there’s one common trap that people fall into when they reconsolidate: they don’t factor in the extra fees that can be charged for closing a loan early and establishing a new one.
WHAT IS DEBT CONSOLIDATION?
Fua has a credit card, a car loan and a personal loan. The balances are all different and the interest rates are all different too. She has to manage three different sets of repayments, and all are paid at different times of the month.
She decides to consolidate her debt. She takes out a new personal loan and uses it to pay off her credit card, car loan and other debt. Now she only has to deal with one repayment, one interest rate and one repayment schedule.
Even better, the new personal loan was at a lower interest rate than her old loans, so she saves money in the long run.
Or does she?
THE DANGERS OF BREAK FEES AND SETUP FEES
When you close a loan or open a new one, you may be charged ‘break fees’ or ‘establishment fees’. In some cases, these extra charges can be higher than the money you’d save by consolidating!
Andy has a car loan and a personal loan. He wants to consolidate his debt. But to set up the consolidation loan, he has to spend extra on an establishment fee. To close his current loans, he has to spend extra on break fees.
After doing the maths, Andy finds out he would save a few hundred dollars on interest payments with the new consolidation loan. But he spends almost that much on the extra fees!
Lots of people make this mistake. You can avoid it by making sure you compare the amount you’d save in interest to the amount you have to spend in extra fees.
DEBT CONSOLIDATION CALCULATOR
1. Use the Sorted debt calculator to figure out how much total interest your current debts will cost you. Write this figure down.
Total interest on current loans: $________
2. Use the Sorted personal loan calculator to calculate how much your new debt consolidation loan would cost you in interest.
Total interest on consolidation loan: $________
3. Talk to the people your current debts are with. Ask them about break fees or early repayment fees for your current loans. Write these figures down. These will usually be written in your loan contract.
Break fee total: $________
4. Talk to the people you want to get a debt consolidation loan with. Ask them about establishment fees (or how much it will take to open a loan with them). Write this figure down.
Establishment fee total: $_______
5. Add the figures from step 3 and step 4 together, then add it the total from step 2. This is how much your new loan will really cost you.
Break fee + establishment fee + total interest on consolidation loan: $_______
6. If the figure is still smaller than the total in step 1, then debt consolidation will save you money!
If the debt consolidation loan is going to be more expensive in the long run, it can still be worthwhile in a few scenarios. If you need to reduce your regular repayments, a longer-term debt consolidation loan can do that - even if it costs more in interest over time.
The next time you take out a loan, make sure to ask about break fees and early repayment fees to make sure you don’t encounter the same problem if you consolidate later.
And lastly, remember that the purpose of getting a debt consolidation debt is to reduce and/or simplify your debt. Don’t be tempted to continue using the old credit card or the overdraft once you’ve cleared it. Cancel them so you can get on top of your debt!