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  Understanding the difference between refinancing and debt consolidation

With the cost of everything increasing, including mortgages and credit card interest rates, many Australians are experiencing debt anxiety. When faced with overwhelming debt, finding a solution can be a daunting task. That’s why we are here to help. We have recently been asked by many clients about the difference between refinancing and debt consolidation.

Refinancing and debt consolidation are two common approaches that individuals may consider to manage their finance burdens. While these strategies aim to alleviate debt related stress, it’s important to understand the key differences between them to make an informed decision.  

Refinancing: A fresh start on your loans

Refinancing is the process of replacing an existing loan with a new one that typically comes with different terms, interest rates and repayment periods. By refinancing a mortgage, borrowers seek to take advantage of more favourable terms or interest rates to reduce their monthly payments, lower interest costs or change the loan structure to better suit their financial goals. 

When we help our clients to refinance their mortgage(s) we research and source a range of finance options from different lenders or sometimes the same lender who issued their original mortgage(s) with the goal of achieving more favourable conditions. 

The new loan is used to repay the balance of the existing loan, effectively closing the previous loan. Depending on the borrower’s goal and circumstances, refinancing may not be just about reducing the overall debt burden, it may also be focused on restructuring the terms of the loan.  

Debt Consolidation: Streamlining multiple debts

Debt consolidation involves combining multiple debts into a single loan. It is commonly used to manage credit card debt or other unsecured loans. The goal is to streamline debt repayment and potentially secure more favourable terms such as a lower interest rate or a longer repayment period. 

With debt consolidation, as your finance specialist, we find a lender who will cover the outstanding balances of your various debts. Once approved, the new loan is used to pay off the individual debts leaving you with only one loan to manage. The new lender may request you to cancel your existing credit cards or reduce the limit to remove the potential of accumulating debt repeating itself.

Benefits of Refinancing Benefits of Debt Consolidation

Lower interest rates
Refinancing may provide an opportunity to secure a loan with a lower interest rate, especially if your creditworthiness has improved since the initial loan. This may result in some substantial interest savings over the life of the loan assuming you maintain the same loan term or continue to make the same loan repayment amount.

Streamlined repayment
By consolidating multiple debts into a single payment, you can streamline your monthly financial obligations into one payment. This can make budgeting more manageable and reduce the chances of missing payments. 

Reduced monthly payments
By extending the loan term or obtaining a lower interest rate, you can lower your monthly payments, providing immediate relief to your cash flow.

Potential interest savings
The goal of debt consolidation is to achieve a combined lower interest rate compared to your individual debts, saving you money on higher interest payments over time. 

Improved loan terms
Refinancing allows you to modify loan terms to suit your current financial situation. This may include switching from a variable rate mortgage to a fixed rate mortgage or changing from a short term loan to a longer term loan.

Repay debt sooner

If you continue to pay the same combined payment amount to your new loan, you will likely notice that your debt can be fully repaid in a shorter amount of time.

Key differences between refinancing and debt consolidation

While both refinancing and debt consolidation involve obtaining a new loan to manage existing debts, there are key differences to consider: 

Interest considerations

When it comes to interest, the implications of refinancing and debt consolidation can differ: 

Potential Drawbacks and considerations

Extended repayment period
Both refinancing and debt consolidation may extend the repayment period compared to the original loans. While this can lead to lower monthly payments, it can also result in paying more interest over the long term. You should consider the impact of an extended repayment period on your overall financial goals and the total cost of the loan. 

Risk of accumulating new debt
When consolidating multiple debts, there is a risk that you may continue to accumulate new debt while repaying the consolidated loan. This can result in a higher overall debt burden and financial strain. It is essential to address the root causes of debt and adopt responsible spending habits to avoid falling into a cycle of debt accumulation. 

Impact on credit score
Both refinancing and debt consolidation can have an impact on your credit score. When refinancing, the credit inquiry and closing of the previous loan may cause a temporary dip in your credit score. Similarly, debt consolidation may also initially impact your credit score. However, if you successfully manage the consolidated loan and make timely payments, it can have a positive impact on your credit score over time. 

Each approach has its own benefits and considerations regarding interest rates, repayment periods and potential impact on credit scores. It is crucial for you to carefully evaluate your financial situation, goals and the terms offered by lenders to determine the option most suitable for your specific needs.  

And that’s why we are here to help and guide you through these finance options and decisions. 

With your best interest always in mind...

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Disclaimer: The content of this article is general in nature and is presented for informative purposes. It is not intended to constitute tax or financial advice, whether general or personal nor is it intended to imply any recommendation or opinion about a financial product. It does not take into consideration your personal situation and may not be relevant to circumstances. Before taking any action, consider your own particular circumstances and seek professional advice. This content is protected by copyright laws and various other intellectual property laws. It is not to be modified, reproduced or republished without prior written consent.

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