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Is Debt Consolidation Right for YOU?

Given the recent rise in interest rates and the effects of the global financial crisis, many mortgagees may be finding it difficult to make desirable purchases or pay off debts accumulated over the Christmas/New Year period. So, what are some of the options for minimizing debt over the long term?


Ask yourself some hard questions first!

 When it comes to big purchases, you have to ask yourself whether you really need to buy this item. In most cases, it is unlikely that you really need to purchase the item now. A new car is not essential if you have either an older car in reasonably good working condition or if you have access to reliable public transportation. Taking the train or bus to work will boost your eco-friendliness because you are not adding to the number of vehicles on the road. If you walk or ride a bike instead of purchasing a new car, then you are not only helping the planet but you are also likely to boost your own levels of fitness too.

 However, some items might be essential. If you really do need a car to get to work, have no access to public transport and you either have no car or one that is becoming more expensive by the minute to fix, then you can probably justify the purchase of a new one. Having justified the purchase, you now need to consider what options you have to finance the purchase.


Financing new purchases: mortgage, car or personal loan?

 If you do not have access to the cash required to make your purchase outright, or do not have the ability to pay off accumulated credit card debt, then you are probably considering either applying for a car/personal loan or adding the purchase/debt to your existing home loan. In most cases, personal loans are going to have a higher interest rate and a shorter loan duration (often between 1-7 years). Adding the debt to an existing mortgage, therefore, is initially more attractive than taking out an additional loan as mortgages generally incur a lower interest rate. Debt consolidation has the advantage of ensuring you have a single, manageable payment for all of your debt each month. No more fines for missed payments! If you choose to consolidate all of your debt (credit cards, bills, etc) with your mortgage than it can also limit the amount of debt you accumulate. One payment, no worries!


However, you should consider whether this is the best option for your circumstances. Are you likely to pay off the additional debt at the same speed you would if you had a short-term personal loan? If you intend to pay off the new debt by increasing your mortgage repayments for a specified period, then extending your mortgage might be the best option for you. You should talk to your mortgage lender and make sure that the terms and conditions of your loan will allow you to pay more than the fixed monthly repayments.


If you do not wish to pay off the additional debt in the short term or if your job is insecure then you need to be aware that you could end up financially worse off. Not paying off the additional debt quickly will increase the amount of your mortgage in the long term. As a result, you might find yourself paying significantly more in interest.

Here is a quick example. 

You are looking to buy a small car worth $15,000 and you consider two alternatives for financing this purchase. The first is with a personal loan of 5 years at an interest rate of 15% per annum, and the second option is to top-up the mortgage.

Under the first scenario, your monthly repayments with the personal loan will be $356.85 or a total interest charge of $6,411 over the 5 years (dependent upon a specific lender's requirements and application fees). So your $15,000 car will actually cost you $21,411 by the time you have paid off the loan.

On the other hand, if you added the cost of the car to your mortgage over 5 years, paying a fixed rate of interest of 7% per annum, you will be making monthly repayments of $298.00. If the additional borrowing is paid off in this time your total interest charge will amount to $2,810, a total of $17,810 in repayments.

However, if you are not disciplined enough to do this, and continue to just pay the standard mortgage repayment , your %15,000 car will add an extra $16,319.00 to the interest on your 25 year mortgage - total repayment on the car of $31,319!

 There are more options than the two discussed in this article. If you are interested in learning more, speak to your financial planner. They will be able to assist you in working out how to best minimize your long-term mortgage debt while still managing to afford the occasional luxury!



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