It is the process of combining existing loans, credit cards and other balances into a single, more manageable financial product with lower interest rates – typically a mortgage.

Confused as to why this is important? In this article, we highlight some of the pros and cons of debt consolidation so you can decide if you should explore it further.

Potentially reduce interest and fees paid overall

Financial products are not made equal, with different interest rates and fees charged depending on the type of liability. In general, credit card debts typically charge the highest interest rates, followed by personal loans, car loans, then a mortgage respectively. The main benefit of debt consolidation comes into full effect when liabilities with higher rates are paid off using the funds from a consolidated loan with lower rates. The interest paid over the total life of the loan can be reduced, and can be paid off sooner if the same repayments are kept as before. Furthermore, you’ll be able to avoid fees incurred from holding multiple financial products.

Repayment flexibility

Lending specialists typically suggest keeping the same repayment plan even for the newly consolidated debts. For example, if you previously paid $1000 per month as a minimum requirement for your car loan with a 10 year term before debt consolidation, you should aim to continue making the same $1000 repayment per month even after you’ve consolidated it. By doing this, the lower interest rate after combining your liabilities usually means you can pay off the loan much faster than before by exceeding the minimum repayment required.

However, debt consolidation gives you the opportunity to be more flexible with your payments. Keeping the same repayments as suggested is essentially an advance in repayments, but can also be adjusted lower if you need more cash for a given period. In the end, it takes great financial discipline and planning to effectively reduce your liabilities.

Streamlined finances

With one consolidated loan, you only need to make one repayment each payment period of the loan. Not only does it save you the hassle of making multiple repayments each time, but it decreases the likelihood of late fees if you miss one. Additionally, depending on the consolidated financial product and strategy implemented, a fixed rate and term can help you stay disciplined and on track to becoming debt-free sooner.

On the flip side, there are a few things to consider before you jump straight in.

Be careful about turning unsecured debt into secured debt.

Many borrowers would be attracted to consolidating debt into their home loan to receive relatively lower rates. Pay attention to the longer loan term however, because it could mean you pay more interest over time if kept over the same 30-year term. Additionally, lenders hold a certain degree of power over mortgage holders because they can take their property in case of default.

Pay attention to the total cost of debt consolidation.

Debt consolidation comes with added costs that are easily overlooked such as early repayment, exit or break fees for current debts. There are also costs associated with refinancing and setting up a new financial product.

These all need to be factored into your decision. It is important to request assistance from a lending specialist or mortgage broker so they can calculate the total cost of debt consolidation to see if it suits your financial position.

Debt consolidation doesn’t get rid of debt.

Consolidating debt makes it appear like you’re clearing off some debt, but essentially, you owe the same amount. While it is a valuable step to becoming debt-free sooner, healthy financial habits need to be adopted to avoid new liabilities in the future.

Any advice provided is general in nature and should be considered in line with your financial situation, needs and objectives.