Loan consolidation is used to roll existing debt—such as the car and boat loan, and credit card debt—into your home loan, usually using a home equity facility. The attraction is a cheaper interest rate and a simpler administrative package (one repayment instead of several) and the opportunity to manage your debt better.

Benefits

You save interest by paying out higher interest rate loans by bundling them into one lower interest rate debt.

Helps organise finances and, if in trouble, can set a borrower on a more disciplined, organised path.

Personal loans generally have lower interest rates and lower fees than other loans or lines of credit such as overdrafts, credit cards or finance company loans.

Results in more streamlined way of paying out a range of staggered interest repayments on different loans, possibly saving a borrower from defaulting on a particular loan and jeopardising their credit rating.

Tips
If used unwisely a borrower can end up 'borrowing from Peter to pay Paul'—shunting a debt from one institution to another.A borrower may not finish paying off the loan with a tangible asset, such as a car, particularly if the loan was used to consolidate a mass of bills.Can lead to undisciplined borrowing in the future if the lesson is not learned that undisciplined use of debt can be expensive.

How is it done?

If you're in financial trouble it's not easy. You need to draw up budgets and an achievable repayment schedule and convince a lender (preferably one you already have a relationship with based on a good repayment record) to provide you with a new loan package. In most cases, the consolidation will be through a personal loan and the interest rate will depend on how good (or poor) a credit risk you are. If it's the home option you're after, a home equity loan can let you access the equity you have built up in your home. Here, it's a matter of drawing down that excess equity to pay off your other debts. Borrowers not in financial difficulty could also look at consolidation through a personal loan—although the benefits can be marginal.

How does it work?

Let's say you have $20,000 in "bitsy" loans--$5,000 outstanding on your credit card at 15 per cent, a $10,000 car dealer loan at 15 per cent over five years, and a $5,000 personal loan at 11 per cent for three years. If you are a reasonable credit risk, you may be able to consolidate these loans at an interest rate of about 9 per cent. It's not cheap, but it is certainly cheaper than what you're paying now. And, unlike credit card borrowings, you are required to commit to a loan repayment schedule to ensure the loan is paid off.

Alternatively, let's say you also have a $100,000 home loan on a property now worth $170,000. That's $120,000 in borrowings that could all be rolled into your home loan. By extending your home loan, you could reduce the rate you're paying on all your loans to the standard variable rate—currently about 6.5 per cent—and reduce your various monthly repayments to just one.

So what's the catch?

You'll usually have to pay a fee to change your loan arrangements. And if your repayment record has been poor, your bank may not be falling over itself to extend you extra credit. But the real danger lurks in your own behaviour. Debt consolidation can be fantastic if you use it as an opportunity to get serious about your loan repayments and get rid of this consumer debt as quickly as possible.

Unfortunately, it's easy to spend the money you're saving on your loan repayments instead of using it to repay your debt. If you're looking at the home equity loan option, you could be paying your car off over the length of your home loan—as long as 25 years—instead of over five years. That will cost you significantly more in total interest charges and isn't the result you're trying to achieve. Credit counsellors warn to be careful not to incur any new loans once your debts have been consolidated. Unfortunately, it's all too easy to start the whole cycle of building up loans over again.

More on home equity loans

This type of borrowing or financial strategy was launched just over a decade ago. Home equity loans are also known as flexible mortgages or revolving line of credit mortgages.

Home equity loans have the following features:

• Allow borrowers to draw down and repay as little or as much of the loan as they want, when they want.
• Home owners who have already paid off a lot of the mortgage are able to get access to the equity they now have in the home by simply refinancing into a home equity loan and then drawing out what they want.

Borrowers should also be aware of the drawbacks of this type of borrowing.

• For some people the ability to tap into the value of their family home is a recipe to run up more debt financing holidays, a new car or a spending spree—people on fixed incomes should be clear on their goal before taking out a home equity loan.
• The home equity can be spent paying for things which are either consumed immediately or which lose value.

While it is always important to compare the rates charged, the decision to take out a home equity loan often depends on a range of other features. These include:

• Fees, including upfront and annual charges
• Minimum and maximum loan amounts
• Whether you can split the loan into consumption and investment portions, and what costs apply if you do
• Whether there is a requirement to draw down a minimum amount or, alternatively, pay a fee for leaving the loan undrawn.