Paul Clitheroe
Paul Clitheroe

Consumers must choose carefully

PERSONAL loans are going head-to-head with credit cards in the battle for debt consolidation. For consumers facing a raft of options, the trick is to choose carefully. What helps one borrower manage their debt may not be the best option for you. 

Debt consolidation - where you fold several high interest debts into a single lower rate loan, used to be the exclusive domain of personal loans. But these days plenty of credit card providers are pitching at the same market, which has lead to some very appealing balance transfer offers, presently ranging from zero percent interest for 6 months to around 4.99% for the life of the outstanding balance.

However self discipline rather than a low rate could be the key to choosing the debt consolidation option that provides the best value for you.

As a guide, financial researcher Canstar looked at two different debt repayment scenarios where $10,000 is paid off over three years using a personal loan charging 10% interest versus a credit card charging 0% for six months and a low rate of 12% thereafter.

If you were to make monthly repayments of around $323, the debt would be repaid in three years using either the credit card or personal loan. The key difference is that the total interest charge for the card would be about $1,353 compared to $1,619 for the loan. That's a saving of $266 thanks to the zero interest introductory period.

But - and it's a very big but, paying $323 each month on a card balance of $10,000 would be well above the card issuer's minimum repayments. It's when borrowers repay just the minimum required payment noted on their card statement that this whole debt consolidation scenario goes nowhere.

Using the above example, if the minimum repayments were based on 3% of the card balance, and that's all the cardholder repaid monthly, there'd still be an outstanding debt of $4,500 at the end of three years.  On the other hand, anyone repaying the debt via the personal loan, with its higher monthly repayments, would have cleared the debt completely by that stage.

You have to be realistic about the type of product that will suit your budget and style of spending when trying to clear a debt. A personal loan provides the advantages of fixed repayments, a fixed term and in many cases a fixed interest rate. On the flipside, taking out a new card with a low introductory rate opens the possibility of making more purchases, not just on the balance transfer card but also on the old (newly paid off) one. And for some, that's too much of a temptation to resist.

Choose the option that you think will not only do the best thing by your pocket, but also by your temperament and money management history.

Paul Clitheroe is a founding director of financial planning firm ipac, chairman of the Australian Government Financial Literacy Board and chief commentator for Money magazine. For more, please visit www.paulsmoney.com.au.



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