Debt consolidation home loans: the monthly saving, and the cost underneath it

What does consolidating debt into your home loan mean?

Consolidating debt into your home loan means paying out your other debts, such as credit cards, store cards, personal loans and car loans, with money borrowed against your home. You're left with one loan and one repayment, at a home loan rate instead of a card or personal loan rate.

It can be done with your own lender, by increasing the loan you have (often called a top-up), or by refinancing, which means moving your home loan to a new lender and borrowing the extra there. Either way, the old debts are paid out from the home loan, usually at settlement, and those accounts close.

Two things change at once. The rate on those debts usually falls, and the time you take to repay them usually stretches from a few years to the 20 or 30 years left on your mortgage. The first saves money. The second can cost more than the first saves, which is what the rest of this guide is about.

Is it a good idea to consolidate debt into your home loan?

Consolidating debt into your home loan is a good idea when the debts end up repaid at the lower rate over a short time, and a poor one when they're left to run for the life of the mortgage. MoneySmart, the government's money guidance site run by ASIC, puts the risk plainly: consolidating "may cost you more if the interest rate or fees (or both) are higher than before", and "if you can't pay off the new loan, the home or car that you put up as security may be at risk" [1].

That second warning is the one people skip. A missed credit card payment used to be a credit card problem. Once the card is inside your home loan, it's a home loan problem.

What this means for you: the question isn't really "is consolidating good or bad?" It's "will I repay these debts faster than I do now, at the lower rate?" If the answer is yes, consolidating usually saves money. If the honest answer is that the lower repayment is the point, the next three parts show what that costs.

How much does debt consolidation save? The monthly saving, and the number underneath it

An illustration, not a client file. You owe $15,000 on a credit card at 20%, $20,000 on a personal loan at 12% with four years left, and $25,000 on a car loan at 9% with five years left. Your home loan rate is 6.0% [3].

Spread over 30 years, your repayment drops by $1,243 a month, but the total interest is over four times what you'd pay now: about $53,000 more. Repaid over five years instead, it saves about $443 a month while all three debts are running, and about $6,900 of interest [3].

Both rows are the same $60,000 at the same rate. The only difference is time.

Where does the saving come from, debt by debt?

The saving from consolidating comes from the lower rate, and the cost comes from the extra years. Split the example into its three debts and you can see each one's share [3].

Repaid at 6.0% over the time each debt had left, the three together cost about $7,973 of interest, against $16,486 now. Spread over 30 years, they cost $69,503 [3]. The car loan shows it most clearly: about $6,138 of interest as it stands, about $3,999 at the home loan rate over its own five years, and about $28,960 over 30 years.

One honest note on the "as now" figures. The $1,603 a month is the three repayments added together, and you only pay all of it while all three debts are running. The card is gone after three years and the personal loan after four, so from then on your repayment falls on its own [3].

How long should you take to repay consolidated debt?

Repay consolidated debt over the time the old debts had left, or faster. Every extra year at the home loan rate adds interest, and the cost climbs faster than it looks. Here is the same $60,000 at 6.0%, repaid over five different terms [4].

Three years costs about a third of what the debts cost now. Thirty years costs more than four times as much.

How to consolidate without the lifetime cost

The way to consolidate without the lifetime cost is to consolidate the rate, not the term. Put the debts into a separate split of your home loan (a split is a second account under the same loan, with its own balance and repayment), and repay that split over the time the old debts had left, or faster.

In the example, carrying on paying the old $1,603 a month into the new split clears the $60,000 in about three and a half years, with about $6,600 of interest [3]. That's less than half the $16,486 the debts cost now, and you're debt-free on them sooner.

A separate split also keeps the job visible. You can see the consolidated balance falling on its own line, rather than lost inside a $500,000 mortgage. Whether a split can be variable, take extra repayments or sit beside an offset depends on the lender and the product, so it's worth checking before you choose one.

What this means for you: the lender sets the minimum repayment, but you set the real one. The minimum is what the bank needs. The amount you choose to pay decides whether consolidating saves you money.

What undoes a debt consolidation?

What undoes a debt consolidation is the spare cash. If the monthly saving gets spent, and the cards are used again, you end up with the old debts back on top of a bigger home loan.

The simplest protections are mechanical. Close the cards once they're paid out, rather than keeping the limits "just in case". Set the split's repayment to the old total from the first month, so the saving never reaches your everyday account.

Which debts are worth rolling into your mortgage?

The debts worth rolling into your mortgage are the ones with a rate well above your home loan rate and years left to run, as long as you'll keep repaying them quickly.

**Usually worth it:** credit cards and store cards at high rates; personal loans well above your home loan rate; and car loans with years left to run.

The bigger the gap between the debt's rate and your home loan rate, and the longer the debt has left, the more the lower rate can save. A card at 20% against a home loan at 6.0% is the clearest case. A car loan at a rate close to your home loan rate, with a year to go, may save almost nothing once costs are counted.

Can you roll a car loan into your mortgage?

You can usually roll a car loan into your mortgage. Check two things first: any early payout fee on the car loan, and whether the loan ends with a balloon, a lump sum due at the end, because the payout figure includes it.

A car loan is often secured against the car. Once it's in your home loan, the car is no longer the security: your home is. That's not a reason not to do it, but it is the trade.

Then repay it over the time it had left. In the example, the $25,000 car loan costs about $3,999 of interest at 6.0% over its own five years, and about $28,960 over 30 years [3]. Thirty years of interest on a car you may well have sold long before is the costliest version of consolidating.

Will consolidating push you over 80%, and what would LMI add?

Consolidating can push your loan over 80% of your home's value, and that's the point where lenders mortgage insurance usually starts. LMI, lenders mortgage insurance, is insurance the lender takes out when you borrow more than 80% of the property's value, and you pay for it. LVR, the loan as a share of the property's value, is the number that decides it.

Here is what the same $60,000 of debts does on a $700,000 home, from one insurer's published rate card, at its standard rates; the card adds no loading for a refinance, though its refinance criteria apply [5]. These are illustrations from one card, not quotes [4].

The middle row is the one to watch. Rolling in $60,000 took the loan from about 74% to about 83% of the value, and the LMI on that one move is about $5,336, on top of every cost in the last part.

What this means for you: if you're close to 80% already, the order matters. Paying down a debt from savings first, or rolling in only the dearest debts, can keep you under the line. Above 80%, lenders' own limits on consolidation also apply, so the answer can change from lender to lender.

Top up with your own lender, or refinance to a new one?

Consolidating can be done with your own lender or with a new one, and the choice turns on rate, costs and how each lender assesses you. Your own lender may increase your loan, or a new lender may take the whole loan and the debts together.

A top-up usually keeps the costs of moving low, at whatever rate your own lender offers. A refinance can bring a lower rate on everything, but adds a discharge fee, government fees and a fresh application. Both mean a new assessment of your income, your debts and your living costs.

Try your own figures on our refinance calculator: it takes up to four other debts and shows the interest both ways, kept separate and rolled in [10].

Bought with the 5% Deposit Scheme? You may not be able to top up

If you bought with the 5% Deposit Scheme, the government's guarantee rules limit consolidating. Your loan can't be increased while the guarantee is in place [9], so a top-up to pay out other debts isn't an option with your current lender.

You can refinance to another lender on the scheme's panel and keep the guarantee, but only without increasing the loan or extending the term [9]. Move to a lender that isn't on the panel and the guarantee is lost, so that lender's LMI rules apply. The guarantee ends by itself once you owe 80% of the value, measured on your scheduled repayments [9].

More on how the scheme works is on the First Home Guarantee page.

What do lenders look for when you consolidate?

When you consolidate, a lender wants two things: that the debts you're paying out have been paid on time, and that you can afford the bigger home loan. Missed payments on the debts being consolidated are what count against you.

Firstmac's published policy, for example, accepts consolidating personal debts from other lenders where those debts have been well conducted. It relies on comprehensive credit reporting and your Equifax score to show the repayment history, in place of refinance statements from each lender. Statements aren't needed where every borrower has a satisfactory score and no defaults, or only a non-financial default that meets its credit history rules [6].

That matters more than it sounds. Gathering months of statements from three or four lenders can be one of the slower parts of a consolidation.

Lenders can also set their own limits on consolidation, such as how much they'll roll in, which kinds of debt, and up to what share of the home's value. Those limits sit in the lenders' own policies, which is why Money Brain checks them before anything is applied for.

Can you consolidate debt into your home loan with bad credit?

Consolidating debt into your home loan with bad credit is hard at a mainstream lender, and how hard depends on what's on your file. Firstmac's policy, for example, treats any history of financial defaults, court writs, petitions or bankruptcy as high risk and declines the application [7].

The one exception it names is narrow: a non-financial default listed by a telco or utility only, for $1,000 or less, shown as paid, with a reasonable written explanation from you [7]. Other lenders draw their lines in other places, and some specialist lenders exist for exactly this.

What this means for you: if your file has a default on it, the lender you choose matters more than the rate. Applying to the wrong one adds an enquiry and a decline to a file that's already working against you.

Can you borrow enough to consolidate? How lenders test the bigger loan

Whether you can borrow enough to consolidate depends on the new, bigger loan passing the lender's affordability test. Banks check you could still make the repayments if rates were at least 3 percentage points higher than the rate you'd pay, the minimum buffer APRA expects them to use [8].

Consolidating can actually help that test. A card, a personal loan and a car loan each carry a repayment in the lender's sums; paid out and closed, they come off. What can work against you is a card limit you keep open, because lenders count a card's limit, not just what's owing on it.

If your income has dropped or your living costs have grown since you took out the home loan, the new assessment can come back lower than you'd expect. See how much can I borrow.

Can you take extra cash out when you consolidate?

You can take extra cash out when you consolidate, but lenders treat it differently from paying out debts, and they want to know what the money is for.

Firstmac's policy, for example, counts any money paid to you directly as cash out, whatever it's for, and the purpose must be clearly stated: "Future Investment" or "Personal Use" on their own aren't accepted. Up to $100,000, with the loan at or under 80% of the value, no further evidence is needed where clear details are given. Above $100,000, it wants documents such as a contract of sale, quotes or invoices [6].

Borrowing a buffer "just in case" alongside a consolidation is the cash version of keeping the cards open. It's worth asking whether you need it.

Will consolidating debt affect your credit score?

Consolidating debt affects your credit file in three ways. Applying for the new loan adds an enquiry. Paying the old debts out closes them, which shows as accounts paid. And once the cards and loans are gone, you have fewer open accounts and lower limits.

Close the cards you've paid off rather than keeping the limits open. A lender assesses you on your card limits, not just what you owe on them, and empty cards are the easiest way to end up with the debt twice.

One application to the right lender is better for your file than several to the wrong ones.

Can you consolidate if you're behind on repayments?

If you're behind on your repayments now, a new loan usually isn't the answer, and most lenders won't approve one. Talk to your lender about hardship first: lenders have teams for this.

The National Debt Helpline offers free, confidential financial counselling on 1800 007 007 [2].

How do you spot a debt consolidation offer to avoid?

The debt consolidation offers to avoid are the ones MoneySmart names: it warns against firms that aren't licensed, that ask you to sign blank documents, or that won't put the costs and the rate in writing before you sign [1].

A firm arranging credit should hold, or work under, an Australian credit licence. Ask for the number before you sign anything. Money Brain's credit representative number is in the byline at the top of this page.

What does a broker cost you?

How a broker is paid, and the rule Money Brain holds against it, is set out in full on its own page: what a mortgage broker costs.

Your first move

You've seen both numbers now: the monthly saving and the total cost. The one question left is which of your debts to move, over how long, and with which lender, and that depends on your rates, your balances, your home's value and how a lender reads your file.

When you're ready, the closing section below is the simplest way to start.