An Introduction To Debt Consolidation
It doesn’t matter if you’re a fresh graduate or if you’re a seasoned member of the workforce, one thing you have to admit is that as a working member of society, debt is pretty much unavoidable.
From your car and housing loans, to your student loans and even your credit card, it is highly unlikely for someone to live a completely debt free life.
This situation means one thing; it’s imperative that you find a good way to manage your debt. In this article, we’re going to have a look at debt consolidation, one of the more popular ways of debt management.
What is debt consolidation?
Debt consolidation refers to the act of taking out a new loan or credit card, to pay off all your previous existing loans and credit cards. Collecting all your separate loan payments under a single loan that is easier for you to pay off.
Here’s an example;
Let’s say you have multiple existing debts at a total of RM65,000.
Debt Balance Interest rate (p.a.) Monthly repayment
Credit card A RM13,000 18% RM650
Credit card B RM16,000 18% RM800
Credit card C RM17,000 18% RM850
Personal loan (two-year tenure) RM19,000 13.45% RM1,005
Total RM65,000 16.78% RM3,305
In this example, you’ll pay RM3,305 every month to clear off all your debts. If you take two years to pay them off, you would pay RM11,538 in total interest.
But here’s how it’ll look after it is consolidated.
Existing debt Consolidated debt under
a new loan (two-year tenure)
Total balance RM65,000 RM65,000
Interest rate (p.a.) 16.78% 4.99%
Total monthly repayment RM3,305 RM2,979
Total interest payable RM11,538 RM6,487
Interest savings RM5,051
So as you can see here, with debt consolidation, you’re actually saving RM5,051 in interest, which is quite a sizable amount.
But how does this happen? Let’s dive deeper.
The aim is to reduce the amount of interest you are paying
The theory behind debt consolidation is actually very simple; you’re looking for a reduction in the amount of interest you are paying every month in your repayments.
In the first table in the above example,, you’re paying RM3305 every month to clear off all your debts. But what you don’t know is that in that RM3305 you’re paying every month, RM480.75 is purely for the interest.
In the second table, you’re seeing how debt consolidation works. Although the total of your debt is still RM65000, you’re paying much less because you’re paying less interest.
However, this does not mean that debt consolidation is a catch-all solution.
The reason the above tables work as a good example of debt consolidation is because the interest rate is set at a rate that is advantageous for the example.
Have a look at what happens if the interest rate is less favourable;
|Existing debt||Consolidated debt under a
new loan (two year tenure)
|Interest rate (p.a)||16.78%||20%|
|Total monthly repayments||RM3,305||RM3,308|
|Total interest payable||RM11,538||RM14,397.45|
See what happens? This is why you should tread carefully if you want to try out debt consolidation. Done wrong, you can be paying more than you were originally.
Advantages of debt consolidation
So, now that you understand how debt consolidation works, let’s see the advantages of debt consolidation.
Fewer bills to manage
As the name implies, debt consolidation consolidates all your existing debts into one big debt, which will save you from headaches of trying to figure out which debts have you already paid for the month, while also saving you from the anxiety of worrying about missed payments.
Get more liquid cash
When you consolidate all your smaller debts into one big debt, chances are you will be paying a smaller amount every month. This frees up more liquid cash for you to pursue other interests.
Save up on interest
Theoretically, if you get a good deal and a good interest rate with your debt consolidation loan, you will pay less interest on your loans, as shown in our example.
Disadvantages of debt consolidation
But even with all these advantages, debt consolidation isn’t a catch-all solution for everyone. There are things that you need to consider before deciding to go through with debt consolidation, and the most important one is;
You might not qualify for a good interest rate
As I’m sure most of you know, the interest rate you get from your loans are given by your bank, depending on several factors such as your credit score and your credit report. If you don’t qualify for a good interest rate, debt consolidation might not be for you as you’ll likely be paying more by the end of your loan.
Debt consolidation is not a debt solution
It merely combines all your debt into one single, more manageable loan. If your current monthly repayments seems smaller in figure, check if it is due to a longer loan term, for which you may be paying higher interest rates.
Remember, if you are having trouble meeting the monthly payments after consolidating your debts and take on another loan, then you are back to where you started.
Make it work to your advantage
If you’re looking for a way to manage your existing debts, then you probably should consider debt consolidation.
However, you do need to do your research and ensure that you’re going to be benefiting from your debt consolidation, instead of paying a lot more.
It’s not perfect for everyone, but if it works for you, give debt consolidation your consideration.