Looking to free up cash flow or improve your borrowing power?
Debt consolidation can be a powerful tool, but it’s not without risks.
In today’s blog we cover:
- How Debt Consolidation Works in Practice
- Why Debt Consolidation Improves Borrowing Capacity
- Debt Consolidation’s Hidden Price Tag – Increased Interest Cost
- How to Minimise Interest Paid on Consolidated Debts – Discipline Makes All the Difference
- Is Debt Consolidation the Right Strategy for You?
How Debt Consolidation Works in Practice
So how does debt consolidation actually play out?
Let’s say you have a home loan with a balance of $750,000 and a car loan with a remaining balance of $30,000 and a $5,000 credit card debt still hanging around.
As part of a refinance, you top up your loan by $35,000, increasing the balance to $780,000.
That extra $35,000? It’s used by the lender to pay off your car loan and clear that credit card debt.
From here on out, those debts are all wrapped up into your home loan, which means you’re managing just one loan instead of juggling several, if they are consolidated into the one new home loan facility.
However, if you’re in a situation where part of your car loan is tax-deductible, you might decide to keep it as a separate loan facility. Totally your call!
The main benefit of consolidating your debts like this is that it can really ease the pressure on your monthly repayments. Plus, it can significantly boost your borrowing capacity—who doesn’t want more flexibility when it comes to their finances?
The consolidation process streamlines your finances, but main reason people go this route is that it can dramatically reduce your monthly repayments and significantly boost your borrowing capacity.
Why Debt Consolidation Improves Borrowing Capacity
The impact of debt consolidation on borrowing power comes down to two major factors:
1. Lower Interest Rate on the Home Loan
Car loans, personal loans and credit cards typically carry interest rates of 7% to 17%.
By consolidating into a home loan, you’re likely moving that debt to an interest rate closer to 6% or lower in today’s declining rate environment.
2. Longer Loan Term
Car loans often have short repayment terms, typically 1 to 7 years, with 5 years being the most common.
Credit cards come with the highest interest rates, and lenders typically assume your credit card is maxed out since the credit is always available. As a result, your borrowing capacity can be reduced by about 3 to 5 times the limit on your card.
Home loans, on the other hand, are usually structured over 30 years, which spreads the repayments over a much longer period.
Here’s how it plays out:
- A $30,000 car loan at 7.5% over 5 years comes with monthly repayments of $943.
- Consolidating that into a home loan at 6% over 30 years drops those repayments to around $178 per month.
That’s a cash flow improvement of about $750 per month for you, which directly increases the amount a lender will let you borrow.
For example:
- A single borrower earning $150,000 could see their borrowing capacity increase by around $130,000.
- A couple earning $300,000 could see a boost of about $150,000.
Debt Consolidation’s Hidden Price Tag – Increased Interest Costs
Let’s revisit the previous example.
Say you originally took out a $50,000 car loan at 7.5% interest over 5 years.
Over the life of that loan, you’d pay around $9,507 in interest.
Now imagine that two years in, you’ve paid down that car loan and have $30,000 remaining.
You decide to consolidate the remaining debt of $30,000 into your home loan at a lower rate, say 6% over 30 years.
Your monthly repayments drop, which improves your borrowing capacity.
But here’s the catch – you’ll end up paying around $34,059 in interest on that $30,000 over the life of the home loan.
That’s almost four times more than the original loan, and it doesn’t include the interest you already paid in the first two years.
How to Minimise Interest Paid on Consolidated Debts – Discipline Makes All the Difference
The loan term might be longer now that you’ve consolidated the car loan into your home loan, but that doesn’t mean you’re locked into it.
If you stay disciplined and make just $100 extra in repayments each month, you could cut the interest cost on that consolidated loan from $34,059 to around $12,869, saving more than $22,000 in the process.
Additionally, if you continue paying the same amount you were on the car loan, plus what you were paying on your home loan, you won’t incur extra interest.
In fact, you’ll save money because your new loan comes with a lower interest rate.
So, while consolidation isn’t a silver bullet, it can be highly effective if you stay committed to your repayment goals.
Is Debt Consolidation the Right Strategy for You?
One of the biggest traps with debt consolidation is behavioural.
Some borrowers consolidate their debts, clear their credit cards or personal loans and then gradually build those debts back up again.
This can create a cycle of spend, consolidate, repeat, which ultimately eats into your equity and financial stability.
If the underlying spending habits aren’t addressed, consolidation can make things worse, not better.
Debt consolidation can absolutely be a smart move, but only when it’s part of a broader financial strategy.
Debt consolidation works best for borrowers who:
- Are committed to improving their financial position
- Understand the long-term cost implications
- Can manage their spending habits moving forward
If that’s not you just yet, it might be worth holding off and focusing on building better financial habits first.
Either way, this is not a decision to make in isolation.
Speak with your strategic mortgage broker before making any major changes.
They’ll help you weigh the short-term benefits against the long-term costs and decide if consolidation fits your goals.
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