Debt consolidation, explained properly

Debt consolidation is one loan that pays out several others. The new lender sends money directly to each existing creditor on the day of settlement, those accounts close, and you are left with a single balance, a single interest rate and a single repayment date.

That is the whole mechanism. Nothing is forgiven and nothing is written off. The total you owe does not shrink at settlement. What changes is the shape of the debt: how many accounts you are servicing, the rate applied to the balance, the term over which it is repaid, and how much of each month's cash flow it consumes.

The benefit comes from two places. The first is the gap between what unsecured credit costs and what secured credit costs. Revolving card debt sits at the expensive end of the market and a loan secured against property sits at the cheap end. The second is simply order. Six due dates become one, and the risk of missing a payment because a direct debit hit the wrong account in the wrong week disappears.

The process is more ordinary than people expect. It looks like this.

Where the funds go

To your creditors

Amount written off

Nil

Accounts left to service

One

Old accounts

Closed, not parked

1. 01

   List every debt from the statements

   Balance, interest rate, minimum repayment, remaining term, and whether the debt is secured and against what. Work from the statements, not from memory. The gap between what people believe they owe and what they owe is almost always in the wrong direction.

2. 02

   Request payout figures

   A payout figure is the creditor's binding number to close the account on a nominated date. It includes accrued interest to that date and any discharge, break or early-termination fee. A statement balance is not a payout figure, and on a fixed loan or a lease the two can differ substantially.

3. 03

   Assessment and serviceability

   The lender tests the consolidated repayment at a rate above the actual rate as a buffer, alongside your living expenses and any debt that will remain. It does not credit you for the repayments you make now. It asks whether the new one is affordable on its own terms.

4. 04

   Valuation and formal approval

   Where property is involved, the lender orders a valuation. Formal approval follows, then loan documents. Mortgage documents usually need to be signed in the presence of a witness, and identification is verified independently.

5. 05

   Settlement and direct payout

   At settlement the funds go straight to the creditors on the payout figures. They do not pass through your account. That is deliberate, and it is why lenders are comfortable with the structure in the first place.

6. 06

   Close the accounts, and check

   A zero balance is not a closed account. A credit card at zero is an open limit that a future lender will assess as though it were fully drawn. Ring each provider, close the facility, and keep the confirmation.

Three variables decide the answer: the interest rate, the term, and the one-off costs of moving. A consolidation can lower your monthly repayment and still cost you more overall, because a lower rate spread across a longer term can produce more total interest than a higher rate over a short one. That is the most common trap in the category, and it is avoidable if you look at the right number.

1. 01Add the total interest you will pay under your current arrangements if you keep making the payments you are making now until each debt clears.
2. 02Add the total interest on the consolidated loan across its full proposed term.
3. 03Add the one-off costs: discharge fees, break costs, application and settlement fees, valuation, and any lenders mortgage insurance triggered by a higher loan-to-value ratio.
4. 04Compare the totals, then compare the monthly repayments separately. Two different questions, two different answers, and you need both.

Where the total interest goes the wrong way, there are two standard fixes. The first is to keep repaying at the old level: take the lower required repayment, then voluntarily pay what you were paying before, and the term collapses. The second is to split the loan, so the consolidated portion sits on a shorter term of its own rather than being smeared across the remaining life of a mortgage.

Preparation shortens the process more than anything else. Expect to produce most of the following.

• Photo identification, and a second form of identification.
• Income evidence: recent payslips for employees, or two years of tax returns, notices of assessment and business financial statements if you are self-employed.
• Three to six months of bank statements for the main trading or transaction account.
• A current statement for every debt being consolidated, plus payout figures once the loan is progressing.
• For business borrowers, recent business activity statements and, where there is tax debt, an ATO integrated client account statement showing the balance and any payment plan.
• Property details: a rates notice, current mortgage statement, and any existing valuation.

Payout figure

The creditor's binding number to close an account on a nominated date, including interest to that date and any discharge or break fee. It is not the balance printed on the last statement.

Serviceability buffer

A margin the lender adds above the actual rate when testing affordability. It is a stress test, not the rate you would be charged.

Loan-to-value ratio

The loan measured against the lender's valuation of the security property. It sets how much is available and, past a certain point, whether mortgage insurance applies.

Lenders mortgage insurance

A one-off premium that protects the lender, not you, once the loan-to-value ratio passes the level a lender is comfortable with. It is usually added to the loan.

Integrated client account statement

The ATO record of what a business owes, what has been lodged and whether a payment plan is running. Business lenders ask for it by name.

The lender then applies its responsible lending obligations. It verifies income rather than accepting a stated figure, assesses declared living expenses against a benchmark, and applies a serviceability buffer above the actual rate. If the assessed repayment does not fit, the answer is no, however much better the structure looks on paper.

• It does not reduce the amount you owe. It moves the balance to a different lender on different terms.
• It does not remove a default, an arrears record or an enquiry from your credit file. Those follow their own retention rules.
• It does not fix a spending pattern. If cleared cards are re-drawn, you now carry the consolidated loan and the cards.
• It does not rescue a business that is not viable. Where trading losses are the source of the debt, refinancing buys time and adds cost. That is a conversation for an accountant and, if solvency is in question, a registered insolvency practitioner.
• It does not stop enforcement already in train. A statutory demand, a garnishee notice or a director penalty notice each carries its own clock, and those clocks do not pause for an application.

Consolidation works where the income is sound and the debt structure is the problem. It fails where the income is the problem and the structure is only a symptom. Signals that it is worth looking at:

• You are servicing three or more separate facilities and at least one of them carries a revolving or short-term rate.
• You have equity in property, or an asset that can carry security.
• Your income covers the consolidated repayment with room left over, not exactly.
• The debt came from a definable event: a bad year, a large tax assessment, a client who did not pay, a period of illness. Something that has passed.

We have seen worse and found the way through. That certainty is the first thing we hand a client.

If none of those apply, say so early. The most useful thing a broker can tell you is that finance is not the answer, and where the answer actually sits.