Written byA debt consolidation loan is a personal loan used to pay out several existing debts, such as credit cards and payday loans, leaving one repayment.
Also known as: consolidation loan, debt consolidation
Key points
- The lender usually pays your existing creditors directly, so credit card and store accounts are closed or left at zero.
- The new loan can be unsecured, or secured against a home or car, which usually costs less but puts the asset at risk.
- Compare the comparison rate, not the headline rate, because it folds in most of the fees a lender charges.
- Stretching the term lowers the monthly payment but can lift total interest, so check the total cost, not just the repayment.
How a debt consolidation loan works
You apply for a loan sized to cover the total of your existing balances. The lender assesses your income, expenses and credit history, and if it approves the application it either pays your creditors directly or releases the funds for you to do it. The old accounts are then closed or left at zero, and one repayment schedule replaces the lot.
The debts most often rolled in are credit cards, store cards, payday loans and other personal loans. Missing repayments on the new loan still counts as a default, and on a secured loan the lender can move to repossess the asset behind it.
Costs and features to compare
Look at the interest rate and the comparison rate together, then the fees: establishment or application charges at the start, monthly account keeping, late payment fees and default interest, and any penalty for paying the loan out early. Shorter terms cost less interest overall but demand higher repayments.
A fixed rate gives certainty for the term and can carry break costs if you clear it early. A variable rate moves with lender pricing, so repayments can rise or fall. Features worth checking are redraw where it is offered, repayment frequency, and whether extra repayments attract a charge; offset is a home loan feature and rarely available on a personal loan.
When it helps and when it does not
Consolidation tends to work when you have several unsecured debts, can get a lower rate than you are paying now, and want a clear payoff date instead of minimum-only card payments. A structured schedule with an end date is easier to plan around.
It works less well when the term is stretched further than it needs to be, when the new rate is no better than the debts it replaces, or when the cards get used again once they are cleared. Closing accounts can also shift your credit utilisation and shorten your credit history, which shows up in your credit rating.
Alternatives worth weighing
A balance transfer card can remove interest for a promotional period, but watch the transfer fee, the limit and the revert rate. Refinancing into a home loan or a redraw usually costs less, though it turns unsecured debt into secured debt and can drag the repayment out for years.
If the pressure is short term, a hardship arrangement with your creditors can pause or reduce repayments without new borrowing. Where the debt is genuinely unmanageable, a debt agreement or bankruptcy is a last resort with long-term consequences. Free counselling is available through the National Debt Helpline.
Not to be confused with
- Refinancing
- refinancing replaces one loan with another rather than combining several debts into one
Frequently asked questions
Is a debt consolidation loan bad for my credit?
Consolidation itself is fairly neutral. It can lower your credit utilisation and make repayments easier to meet. The application does trigger a credit enquiry, and closing old accounts can change your credit history, but how you manage the new loan matters most.
Is interest on a consolidation loan tax deductible?
Interest on a personal consolidation loan is generally not deductible, because the borrowing is not producing assessable income. The treatment can differ where the funds are used for an income producing purpose. Check the ATO's guidance or speak with your accountant.
Can I consolidate debt with bad credit?
It is harder, and the options narrow. Some unsecured lenders will still look at it, and a secured loan may be available, though pricing is higher. Free advice from the National Debt Helpline is worth getting before you take on a new loan.
What is the difference between secured and unsecured consolidation?
A secured consolidation loan is backed by an asset such as a home or car, which usually brings the rate down but puts that asset at risk if you fall behind. An unsecured loan has no collateral, so it costs more but nothing is pledged.
Do I need to close my credit cards after consolidating?
Not always, though leaving the limits open is a risk if the balances creep back up. Reducing the credit available to you lowers your utilisation, which helps your credit file. Some lenders make closing the accounts a condition of the loan.
Related terms
Personal loan
A personal loan is a fixed term loan for personal expenses, repaid in regular instalments over an agreed period, usually principal and interest.
Read definitionUnsecured loan
An unsecured loan is credit you borrow without pledging collateral, so the lender relies on your income, credit history and capacity to repay.
Read definitionCredit card
A credit card is a form of revolving credit that lets you borrow up to a pre-approved limit for purchases, cash advances or short-term finance.
Read definitionComparison rate
A comparison rate is a single annual percentage that combines a loan's interest rate with most upfront and ongoing fees to show its ongoing cost more clearly.
Read definitionCredit rating
A credit rating is an independent assessment of how likely a government, company or debt issue is to meet its obligations on time, graded from AAA down to D.
Read definitionHardship
Financial hardship is when a change in your circumstances, such as job loss or illness, means you cannot meet your loan, credit or bill repayments on time.
Read definitionGo deeper
Sources
This article is general information only and is not financial advice.