Debt Consolidation Strategies

The best debt consolidation strategies usually require a bit of research and becoming familiar with on-line calculators.

This is because the nature of financial calculations is critical to assessing whether or not a debt can be paid off more efficiently using a home loan or a personal loan.

It doesn't mean you have to be a financial whiz or a mathematical genius to make sense of your finances, there are plenty of on-line calculators that will make your life easier and well worth the effort.

Before you start however, you should understand a few basic principles of how home loans and personal loans are calculated in the first place.

Personal loans are normally calculated using an interest rate which is determined at the start of the loan and does not change during the term. In other words if you obtain a personal loan today at 11.5%, repayments will be calculated at the same interest rate throughout the entire term of the loan irrespective of what happens in the marketplace. This means that if interest rates rise or fall, there will be no difference to your repayments and you will still only be required to make the same monthly repayment.

Some personal loans have early repayment penalties so it is not always a straightforward matter when you want to refinance. You need to take into account all of the expenses in making your decision as you will see later.

Home loans are calculated on a time based calculation which means that the balance of the loan, as calculated after each monthly repayment is made, is determined by the applicable interest rate which may rise and fall according to market conditions, and the remaining term over which the loan was made. Although this may be a little difficult to understand, all you need to know is that the interest payable on a home loan is much higher at the beginning of a loan than it is at the end. This means that the loan balance appears to change very little in the first five years of a 30 year term but the balance lowers at an accelerated rate as time goes on.

One vital principle that emerges from this examination is that whilst a home loan will generally require a lower monthly repayment, the interest paid over a longer term can be very great indeed. This is the effect of the time based principle mentioned above.

For example a $400,000 home loan over a 30 year term at a 7% rate of interest will require a monthly repayment of $2645.78. Over 30 years the total repayments amount to $952,479.46 or nearly 2.4 times the amount borrowed.

On the other hand, a personal loan of $30,000 over 7 years at an interest rate of 11% would require a monthly repayment of $509. The total 7 year repayments would total $42,756.60, 1.43 times the amount borrowed.

This comparison shows you the difference time can make to the interest charged and the total repayments made and should give you an insight into why banks like home loans more than personal loans!

But there is a way to use a home loan to pay for personal loans quicker and cheaper, and it comes about by understanding the above principles. It's quite simple really, all you have to do is use the lower rate of interest charged through a home loan and make higher repayments than the minimum. If you do this you'll take advantage of the time based calculation and actually save money.

Let's look at the same example again to see how this works.

If you were to borrow $30,000 as a home loan instead of a personal loan, using the above figures the home loan would require a monthly repayment of $198.43. At this rate the $30,000 will be paid off over 30 years and would cost a total of $71,435.96.

But, if you were to make repayments of $509 per month, as you would have done if it was a personal loan, it would be paid off in just under 72 months at a total cost of $36,603.65.

You can now see the power of a home loan over a personal loan when you use it properly. In this example you would save $6152.95, simply by using the home loan to its best advantage.

So the best way to use a home loan as a debt consolidation strategy is to look at the overall effect that time based payments bring to the equation and use a calculator to work out how much you need to pay on a monthly basis to get a better result than a personal loan.

The main points to consider are as follows:

You must be prepared to make higher repayments than the required minimum monthly home loan repayment.

As a benchmark, you should make the same repayments on your home loan that the personal loan would have required you to make.

Understand that the benefit of time based payment calculations used in home loans can be your greatest asset when it comes to reducing debt and minimising interest repayments.

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