It is not uncommon for one household to have a mortgage, a car loan, a personal loan and credit cards. In fact many households have multiple credit cards with varying credit limits. The repayments on these loans and credit cards fall due at various times of the month and in differing amounts.
In addition, bearing in mind that interest rates on car loans, personal loans and credit cards are usually much higher than those of a home loan, it may seem sensible to consolidate all debts. Consolidation also means one regular monthly repayment instead of attempting to negotiate the multiple repayment amounts and dates every month.
Currently interest rates on car loans can slot in anywhere between 9.50% to 13.45% and are usually taken over a period of three to five years. Unless there is a balloon payment (or residual) value at the end of the term, the monthly repayments can be very high making a big dent in the household budget.
These are much the same as car loans and often set over a period of five years. However, there is no room to have a balloon payment at the end of the term and the monthly repayments can be on the high side.
Credit Cards do not have a set monthly repayment amount. The repayments depend on the usage of the card in a particular month and how much of it is paid off regularly. The most cost-effective way to use a credit card is of course to pay the outstanding balance in full at the end of each month. This saves having to pay interest. Most people, however, do not have the disposable income to achieve this and only pay off the minimum amount due at the end of each month. This means that they pay interest on the outstanding balance in future months and if they keep using the card, the balance is never paid off.
However, consolidating debts is not as cut and dry as it sounds. It is important to bear in mind that:
- It will increase the home loan debt and monthly repayments, and
- The other debts are being paid off over a longer period of time than originally intended.
Nevertheless, all is not lost. There is a smart money way to overcome this. Assume that a household has the following debts:
- Home Mortgage Loan Monthly repayment $1,000
- Car Loan (3 years – no residual) Monthly repayment $700
- Personal Loan (5 years) Monthly repayment $600
- Credit Cards Monthly repayment $300
- Total monthly repayments $2,600
Once the debts are consolidated and the car loan, personal loan and the credit card balances are paid off, the monthly Home Loan repayment might be $1,500 per month. This is because the car loan (instead of being paid out in three years) and the personal loan (instead of being paid out in five years) are now being paid out over the term of the home loan (which could be as long as 25 years).
However, the household now has an additional disposable income of $1,100 per month. Therefore, smart money sense would be to pay an additional amount off the home loan. Say they opted to pay $2,000 per month, it would still leave them $600 per month better off and the additional $500 they are paying into the home loan will help to pay that loan off quicker. (Please note that the figures quoted are for illustration purposes only and have no bearing on an actual situation).
Careful budgeting and consolidating multiple debts together with disciplined repayments will be a ‘win/win’ situation for the household.