Is debt consolidation right for you?

Debt is an unavoidable fact of life, but when you start racking up a considerable amount of bad debt, particularly on credit cards, that's when you need to start to take concrete measures to improve your financial standing.

Recent illion statistics indicate that over one-fourth of Australians anticipate a higher level of household debt over the next few months, and that one in three would be unable to cover basic expenses for longer than a month if they lost their job.

With debt levels on the rise in an uncertain economy, many consumers are thinking of consolidating their debt. However, not many know what it really is or if this method is right for them. Here are some questions that you may want to ask yourself.

Do I know what it means?

According to GE Money, debt consolidation is the process of gathering your various credit card debts, loans and other liabilities and combining them into one loan - also known as refinancing.

This means that you only have one regular payment to manage, instead of different amounts of different days to different lines of credit. This option means that the financial institution which provides the loan can issue payments on your behalf to various credit providers.

Who should use debt consolidation?

Credit card comparison website, Credit Card Finder, states that some types of people may benefit from debt consolidation, while others may incur increased costs in the long run (see below).

If you fall into one of the following groups, debt consolidation may be helpful.

  • You're unable to pay off your monthly bills - Debt consolidation can cut down the number of repayments made and make it easier for debt management, particularly if your cards are nearing or have reached their limit.
  • You have available credit on a low-interest card - Consolidating all low-interest credit cards onto one low-interest card with a balance transfer will help save you interest and effort.
  • You have home equity - This means that the interest rate on your home loan will be much lower than a credit card or personal loan.

Will this incur increased costs for me?

You should always do your research before entering into debt consolidation with a company, as it may or may not be right for your financial situation. Credit Card Finder states that if managed incorrectly or if you choose the wrong debt consolidation choice, the consequences could be dire.

While this means that some people will be paying less money in fees and interest, ASIC's Money Smart warns that for some others, it may be only a short-term fix, particularly if you can't meet the repayments on your new loan.

"There will often be extra fees and charges to pay as well, and some people end up paying more interest on their new loan. Even if the interest rate is lower on the new loan, paying a short-term debt like a credit card or personal loan over a very long term means you will still pay more in interest and fees in the long run."

ASIC also states that consolidation may lead to borrowing more money, for example if your credit card balances are transferred onto your home loan, you may put new debt on your credit cards.

"If you use the consolidation debt simply to increase your overall level of debt, you'll probably make your financial problems even worse," ASIC says.

Should I check my credit report?

You should also check your personal credit report before applying for a debt consolidation loan as it allows you to see how your financial profile is portrayed to potential credit providers. It also allows you to dispute any inaccurate information or detect any instances of fraud that may affect your credit application.

Check your credit report here »

Should I seek external help?

When in doubt, always seek external help from an independent legal advisor, financial counsellor or financial planner. Financial counselling is provided free of charge by community legal centres, community organisations and certain government agencies. They can help you gain a clearer picture of your finances, give you additional options and help you budget, among others.

However, according to ASIC you should always be on guard against predatory brokers and credit providers, which could turn out to be scammers. Warning signs include brokers who push you to make a decision, make unrealistic promises about getting you out of debt or refuse to discuss repayments.

"Anyone who asks you to sign blank documents, rushes the transaction or won't put all loan costs and the interest rate in writing before you sign up is not to be trusted," ASIC says.