When debt consolidation is a bad idea

Debt consolidation is a good tool. Like every good tool it gets used in situations it does not suit, usually because the monthly repayment drops and that feels like progress. Here are the situations where we say no, or where we tell a client to do something else first.

1. 01

   The spending has not changed

   Clearing four credit cards and leaving the accounts open is the classic version. Within a year the cards carry balances again and the consolidated loan sits underneath them. You now have more debt than when you started, and less capacity to fix it. If the accounts are not being closed as a condition of settlement, close them yourself.

2. 02

   The business is not viable

   If the debt came from sustained trading losses rather than a definable event, refinancing converts a solvency problem into a slower and more expensive solvency problem. That is a question for your accountant and, where solvency is genuinely in doubt, a registered insolvency practitioner. Borrowing is not the answer to a business that does not cover its costs.

3. 03

   The term stretches a short debt across decades

   Absorbing a two-year debt into a mortgage with twenty-five years left can multiply the total interest even at a much lower rate. Split the loan onto a shorter term, or keep repaying at the old level voluntarily. If neither is available on the structure being offered, the structure is wrong.

4. 04

   The exit costs swallow the benefit

   Break costs on a fixed loan, early-termination fees on leases and asset finance, discharge and registration fees, a fresh valuation, and lenders mortgage insurance re-triggered by a higher loan-to-value ratio. Add all of it before deciding. On a modest balance these can easily exceed the interest saved.

5. 05

   The security exposes something you cannot afford to lose

   Moving unsecured debt onto the family home changes the worst-case outcome from a judgment to a repossession. Where income is volatile or the repayment only works on optimistic assumptions, that is the wrong trade even when the rate looks better.

6. 06

   The timing is wrong

   Applying in the middle of fresh arrears, days after a default has been listed, or while a hardship arrangement is running, invites a decline and adds an enquiry to your file for five years. Sometimes the right move is to stabilise for three to six months and apply from a stronger position.

7. 07

   There is a cheaper route sitting unused

   A hardship arrangement with the existing provider, a payment plan arranged directly with the ATO, invoice finance against receivables already earned, or simply selling an asset the business no longer needs. Each of these can be better than new debt, and none of them pays a broker anything.

Before any application, work through this honestly on paper. It takes twenty minutes and it is more useful than any calculator.

1. 01Where did this debt come from. Name the event. If you cannot name one, the cause is ongoing and refinancing will not touch it.
2. 02Has that cause ended. A bad year that finished is a different proposition to a margin that has been negative for three years.
3. 03What is the total interest under the current arrangements, and what is it under the proposal across its full term.
4. 04What are the one-off costs of moving, all of them.
5. 05Can the new repayment be met from surplus that already exists, without assuming revenue growth.
6. 06What happens if income falls by a third for six months.
7. 07What is being pledged as security, and what does losing it actually mean.

Break cost

The charge for leaving a fixed-rate loan early. It reflects the lender's cost of unwinding the fixed term, so it is not a set fee. Ask for the figure in writing before you commit.

Discharge fee

What the outgoing lender charges to release its security and close the loan out.

Loan-to-value ratio

The loan measured against the lender's valuation of the property. Pushing it higher is what re-triggers mortgage insurance on a refinance.

Lenders mortgage insurance

A one-off premium protecting the lender, not you, once the loan-to-value ratio passes the level a lender is comfortable with.

Split loan

Carrying part of a mortgage as a separate portion with its own term, so consolidated debt amortises on its own schedule and finishes when it should.

The most common way a good consolidation turns bad is the re-run. Balances are cleared, the accounts stay open, and over the following months they fill again. It is rarely reckless behaviour. It is usually the same underlying cash-flow shortfall that created the balances in the first place, quietly still there, now with an extra loan sitting on top of it.

The defences are unglamorous and they work. Close the facilities at settlement and get written confirmation. Keep one small card with a modest limit if you need one for genuine business use, and no more. Build a buffer, however small, so the next unexpected invoice does not go straight onto credit. If a business's cash-flow gap is structural rather than occasional, deal with it structurally, with terms, pricing or a working capital facility sized for the actual cycle.

For balance, this is the profile where it works well, and it is common. A trading business with real revenue and a real margin. A definable event that created the debt: a large assessment, a client that went under, an equipment failure, a period of illness. Debt spread across several expensive facilities. Equity in property, or an asset that can carry security. Income that covers the consolidated repayment with room to spare.

In that situation, consolidation does exactly what it says. Cash flow improves, the total cost falls, the credit file steadies, and the owner gets to run the business instead of managing six due dates. That is the case we take on, and it is the reason we do this work.

• The total cost over the full term, not just the monthly repayment.
• Every fee, including the ones payable to third parties.
• What security is being taken and what enforcement would actually mean.
• Whether a cheaper or simpler route exists, even if it means no transaction.
• That any figure produced before a formal assessment is indicative only, is not an offer of credit or a quote, and is not a guarantee of approval.
• Where the question genuinely belongs with a registered tax agent, an accountant or an insolvency practitioner rather than a broker.

We tell you the true state of things early, and we do what we say we will do.

If a broker will not put the total cost in writing, or brushes past the security question, that tells you what you need to know. WeL’nd operates as a credit representative, is a member of the FBAA, and offers external dispute resolution through AFCA. Those are the mechanisms that hold us to this, and they exist for you to use.