Is debt consolidation the answer for struggling households?

Debt consolidation loans have skyrocketed amid deepening financial hardship, leading to some Australians to turn to high-cost credit facilities.

Consolidating debt can help you save money on fees and interest by rolling multiple loans or credit card balances into one repayment, which means you could be able to pay off your debt faster. But the convenience can also cost you more in the long run.

Research shows that mortgaged homeowners are increasingly seeking out high-cost credit facilities, with an increase of 170% in debt consolidation loans over the past year. The average debt consolidation loan is around $33,000, but as high as $68,000 in the same period.

The number of debt consolidation loans above $20,000 has also doubled in the same period, the research from Lendela shows. 

Young adults (ages 18-29) represent the fastest growing demographic for debt consolidation loans, with a 62% increase in share of applications over the past six months. Middle-aged (ages 40-59) borrowers account for 45% of debt consolidation loan applications on average, representing the largest group.

“Over the past year, we’ve observed multiple signs that point to growing consumer stress, with many Australians increasingly relying on high-cost options like Buy Now Pay Later, salary advances and other revolving credit facilities,” Lendela Australian country manager Jake Osborne.

Financial lifelines

In a worrying sign of the times, research shows that half of all households have turned to credit cards and other financial lifelines to stay afloat and pay day-to-day expenses this year, research shows.  

A sizeable amount of damage has been done to household budgets due to the cost of living crisis, but data shows the worst may yet to be come, Illion data shows.

Home loan consumers continue to struggle however credit stress isn’t confined to households carrying the financial burden of a mortgage. Renters are also being adversely affected by rising costs, despite signs of rental and interest rate stability.

REA Group senior economist Paul Ryan says homeowners typically turn to debt consolidation services in higher interest rate environments.  

REA Group senior economist Paul Ryan says high interest rate enviornments can lead people to look to consolidate debt. Picture: Supplied

Mr Ryan warned those considering debt consolidation to bear in mind that while consolidation can make multiple debts more manageable by streamlining debts down to one monthly payment, the cons are that you will pay more in fees for the convenience.

It can also lengthen the time it takes to pay off your home loan so be sure to do your research, Ryan says.

Repayment timeframes

Consolidating debt can work well if you’re unable to get on top of credit card debt because the monthly interest component is high, says Sydney-based Mortgage Choice broker James Algar.

“If you’ve got a $20,000 car loan and you consolidate that repayment into your home loan, a lot of people simply look at the monthly repayment and misunderstand the fact that you’re spreading that car loan repayment over the life of the home loan, so it’s going to cost you significantly more over the life of the loan to pay it back,” Algar explains.

He warned mortgagees against falling into bad habits, adding that he has seen people every year with another $20,000 spent against their home loan.

“You’ve got to balance the immediate needs of trying to help with more cash flow, but it does come with a potential sting in the tail if they don’t make a conscious effort to try and pay that debt back as quickly as they can to reduce the interest they are paying,” Algar says.

A word of warning

But there are risks. Avoid companies that make unrealistic promises, with some companies operating in Australia making unrealistic promises, warns MoneySmart.

Check the debt consolidation service is licensed on the Australian Securities and Investments Commission website by choosing credit licensee or credit representative in the drop down menu when searching.

Also, make sure you calculate some of the typically unforeseen costs, such as penalties for paying off your original loans early, application fees, legal fees, valuation fees and stamp duty, MoneySmart warns.

It’s also important to consider other options first, talking to your mortgage provider to see if there could be a better deal in the market with an alternative financier.