Did you know debt consolidation isn’t just a neat way to tidy up your finances, it’s a potent strategy that can boost your long-term property investment power? Here’s how.
First, let’s unpack debt consolidation. How does it work?
Different loan types (for example car loans, student loans, credit card etc) attract different interest rates. Some of your loans might be charging up to 20% interest, costing you a small fortune across the term of the loan or life of the outstanding credit amount.
Debt consolidation is a simple tactic to roll high interest debts into one low interest-rate loan – typically, your home loan. Thus, you’ll generally pay less per month across all your loan repayments.
How to do it (and what to do if you don’t have a home loan)
- If you have a home with a mortgage:
You’ll need some equity in your home so you can refinance and roll your other debts into your home loan. Lenders will usually only let you borrow up to 80% of the value of your home, so you’ll need to have enough paid off to satisfy their terms and swallow your other debts as well.
- If you don’t have a mortgage:
You can package all your debt into one personal loan, using the lowest interest rate available. Rates can vary, but typically start between 5% and 7%. You’re still getting the benefits of one payment, lower interest rates on some of your other loans, and one single final payment date you’re working towards.
Here’s how it looks in terms of repayments and dollars saved:
|Amount still owing||Monthly repayment|
|$475,00 home loan (based on 4% interest)||$330,000||$2,508|
|4 year car repayment (based on 5.5% interest)||$16,000||$306|
|Credit card debt (based on 18% interest, 2.5% min. repayment)||$7,500||$191|
The total amount being paid each month in loan repayments is $3,005. Now let’s look at consolidating the car loan and the credit card debt into the mortgage.
In this example, we’re assuming some of the principle of the home loan has been paid off, and the property is now valued at $500,000. That provides $70,000 in available equity to use for refinancing and absorbing other debts.
These are the new figures after consolidation, assuming the interest rate remains 4%:
|Amount owing after consolidation||Monthly repayment|
|Home loan (based on 4% interest, 25 year term)||$353,500||$1,876|
|Total saved per month||$1,129|
The monthly savings are evident: $1,129 is no small sum. To be very clear though, consolidation doesn’t make bad debt go away! It makes it more manageable in the short term, and gives you more options for long-term income creation.
What makes debt consolidation a powerful investment strategy
At this point, many would point out that one of the downsides of debt consolidation is the loan term has stretched out to 25 years again, meaning you’re paying more interest on those small loans in the long term.
That’s a valid statement, and one you need to think about before consolidating. On top of that, believing the credit card debt is wiped can lead to major binge-spending for some people.
That’s why you have a plan in place for your debt consolidation strategy.
Plan 1: paying down your debt faster
If you structure your loan and your budget effectively, you can pay down your debt faster and mitigate the extra years – and more interest owed – on your new consolidated loan term. You can adopt strategies like these:
- Find a lower interest rate when refinancing
- Use an offset account against your home loan to reduce the principal being charged interest
- Use a budgeting strategy to pay more than the minimum each month. Even paying $100 extra per month in our example above would save almost $20,000 in interest and shave two years off the loan term!
Plan 2: using your consolidated loan to invest and create more income
Firstly, consolidating your bad debt into one personal loan or home loan reduces your monthly expenses, makes you more favourable to lenders when you apply for an investment loan.
When you invest, you ultimately pay down the mortgage using rental income (and any of your own contributions if the property is negatively geared).
Once the property starts paying you a passive income, all those earnings can go right where they belong – paying down your bad debt. Remember how adding $100 per month took two years off the loan term? What if you were able to contribute $800 in rental income each month?
Well, you’d save ten years, and $93,000. That’s a good return from transforming those high-interest loans into an investment strategy!
How do you get started consolidating debt?
It’s a good idea to work with professionals when you’re restructuring your loans. Making sure you have a plan in place is critical for long-term success – otherwise, you’re just drawing out the pain of loan repayments, and you might fall back into old patterns of spending.
We’re specialists at debt consolidation strategies and property investment, and our team is happy to answer your questions. If you’re paying multiple loans each month, debt consolidation might be your first step to designing a wealthier future – you only need to ask.