New loan, same old problems?
If you have a problem managing your repayments, it can sound like a good idea to roll all of your loans into one – for example, a home loan or personal loan. Consolidating or refinancing your loans can work for some people if it means they will be paying less in fees and interest. For others, it may be only a short-term fix, especially if you can’t meet the repayments on your new loan. There will often be extra fees or charges to pay as well – and you need to take care that you don't end up paying more interest on your new loan.
Download our factsheet: Can't pay your debts?
Talk to your credit provider
If you’re having long-term problems trying to repay your home loan, try to come to some arrangement with your existing credit provider first through negotiation or by applying for a hardship variation (see trouble with debt).
If this isn’t possible and you are struggling to keep up with morgage repayments, you may be better off taking the hard decision to sell your home so you have some money left over after repaying your debts.
Otherwise you could pay substantial fees to refinance and still end up having to sell your home, with less money left over for you after the sale. | |
David and Carole didn't check the fine print before signing
David and Carole were delighted with their new home. But four years after buying it, David was made redundant. They began to fall behind in their repayments and got worried that their credit provider would sell their home to repay the loan. They approached a broker who advertised that he could help people in arrears on their loans. By the time he had refinanced their loan, they were over three months and more than $5,000 overdue on repayments.
The broker and the new credit provider charged them over $30,000 in fees and costs to refinance. David and Carole soon discovered that they were paying a higher interest rate on the new loan (9.95% instead of 7%) and that the repayments were $500 a month higher than on their previous loan. Within 12 months of refinancing, they had to sell their home.
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What to watch out for
Interest rates, fees and costs
The most important thing to get right when you borrow money is the interest rate. If you're thinking about taking out a new loan to consolidate your debts, make sure your new interest rate, including fees and costs, is significantly lower than what you're paying over all the debts you're consolidating. If you end up paying higher interest, you're losing money and making your problem worse.
Bear in mind that, even if the interest rate is lower on the new loan, paying off a short-term debt (like a credit card or personal loan) over a very long term (such as a home loan) means you will still pay more in interest and fees in the long run.
If you have a home loan, which typically charges a lower interest rate than other kinds of credit, an option you could explore is to re-draw against it to pay out all your higher-interest loans. Increase your home loan repayments by as much as you can afford in order to pay off the extra debt as soon as possible.
Hidden costs
Existing loans may impose penalties or costs if you pay them off early.
Your new consolidation loan may be secured against your home or other assets. This means you may have to pay extra for applying, legal work, valuation and stamp duty.
Making yourself and others more exposed
If all of your unsecured debt (for example debts incurred on credit cards and store cards) is turned into a secured debt over the family home, then you've created some extra risk that your home could be on the line if things go wrong.
If your home is owned with someone else, they will also be 100 percent liable for any new loan that's secured over the whole property. Similarly, if you have to ask someone to be a guarantor for your new loan, you'll be exposing them to financial risk. See loans involving family and friends.
Getting in deeper
Consolidation may allow you to borrow even more money. For example, if your existing credit card balances are transferred onto your home loan, as part of the debt consolidation, you might be tempted to put new debt on to your credit cards. Or, if you get a line of credit (see choosing a home loan), your borrowing limit may be more than your current debts. If you use the consolidation loan simply to increase your overall level of debt, you'll probably make your financial problems even worse.
Churning
Some mortgage brokers or lenders make a commission if they persuade you to switch loans.
Sometimes they make misleading claims about how much you could save in order to sell you a new loan, especially lines of credit. See switching home loans for tips on what to think about before changing your loan.
Predatory brokers and lenders
Avoid brokers who make unrealistic promises about getting you out of debt or who use advertisements claiming they can help no matter how desperate your financial situation is. Anyone who asks you to sign blank documents, refuses to discuss repayments, 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.
'Equity' is the proportion of your property that you own outright. For example:
- If there is no mortgage outstanding on a property in your name, you own 100% of the equity. If you sold the property, all the sale proceeds would belong to you.
- If you owe $100,000 on your mortgage and your home is worth $200,000, you own 50% of the equity. If you sold the property, half the sale proceeds ($100,000) would belong to you and half would go to repay your mortgage.
'Equity stripping' is when someone takes advantage of borrowers in difficulty and exploits their desire to save their home by:
- charging high fees, sometimes more than 20% of the equity in the home; and
- arranging for a refinancing arrangement where it is extremely unlikely the borrower will be able to afford the new repayments.
Be realistic about whether you can afford repayments under a new refinancing arrangement if you are already under financial stress. You may need to consider making the tough decision to sell your home or downsize rather than tapping into your equity in an attempt to keep your home.
If you do refinance but can’t afford the new repayments, you may end up being forced to sell anyway – and there will be less equity left to repay your debts and make a new start.
Get help from a free financial counsellor or community legal centre
Get independent legal advice or see a financial counsellor before you make any refinancing or debt consolidation decisions to make sure you'll be better off.
Free financial counselling
Financial counselling is a free service offered by community organisations, community legal centres and some government agencies. A financial counsellor can help you get a clear picture of your situation, provide information about your options and work out a budget. Find a free financial counselling service in your area.
Free legal advice
Free legal advice is available around the country from community legal centres and Legal Aid offices in each state and territory. They can help you with disputes with credit providers and debt recovery through the courts. Find a free legal advice service in your area.
If you're having trouble paying your debts now, you stand little chance of paying back a loan with a sky-high interest rate. Check what a bank, credit union or building society can offer you. If they can't help, you may be better off looking at options other than refinancing your loan. It is wise to seek independent legal advice or talk to a financial counsellor before changing your current arrangements.
More information
FIDO Website: Printed 09/10/2010
Download our credit factsheets.
