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Mybudget
Struggling with credit card debt? Some of your options.
By Tammy Barton


Credit Card DebtAre you struggling with credit card debt? Are you thinking about a debt consolidation loan or a credit card balance transfer? Both options come with pros and cons. Let’s examine them and see what’s right for you.

Credit card balance transfer

Transferring the balance of a high interest credit card to a new credit card which comes with a reduced interest rate for a period of time (known as a “honeymoon” period) can come with significant advantages, but there are also pitfalls to be wary of.

Pros: A balance transfer may very well lower your minimum repayment and improve your cash flow. If you’re disciplined, it’s a good opportunity to reduce your debt by paying down as much of the balance as you can afford each month before the honeymoon period ends.

Cons: A balance transfer may free up cash flow in the short-term, but this option rarely addresses the underlying problem: reliance on credit. Credit reliance can only be overcome by eliminating debt and starting to save. There’s a risk, therefore—especially if you’re not financially disciplined—that you may still find yourself with an unmanageable balance at the end of the honeymoon period. Even worse, those people who don’t adjust their spending habits may end up maxing out both the new and old card. (It happens to even the most well-intentioned people.)

Debt consolidation loan

If you have a mortgage, it can be attractive to roll your other loans (credit card, car loan, store charge card etc) into your home loan.

Most mainstream lenders will require a debt consolidation loan to be secured by real estate. Unsecured debt consolidation loans tend to attract a higher rate of interest which makes them unaffordable for many people.

Pros: The main advantage of debt consolidation is that the interest rate on your mortgage is very likely lower than the interest rate on your other loans. The logic is that debt consolidation reduces your combined repayments to free up cash flow.

Cons: Debt consolidation may free up cash in the short-term, but it can lead to a higher repayment figure in the long-run. Compare these two scenarios:

    • Scenario 1: $10,000 charged at 15% interest per annum over five years = $12,022 total repayment amount
    • Scenario 2: $10,000 added to an existing home loan of $250,000 at 7.5% interest per annum over 25 years = $22,169 total repayment amount

The effects of compounding interest make the cost of repayments in the second scenario more than double the original loan figure. You may also be hit with fees for making a loan variation.

Also keep in mind that if you default on your car loan, you risk losing your car. If you default on your mortgage, you risk losing the roof over your head.

Is there another option?

Paul Clitheroe, one of Australia’s leading personal finance experts, writes:

“The key to successfully consolidating your debt is sticking to a budget—otherwise you simply end up accumulating other debts again.”

Without having a personal or household budget in place, debt consolidation or a credit card balance transfer are potentially just Bandaid measures. They free up cash flow in the short term, but they often fail to address the underlying causes of credit reliance.

Budgeting is the only way to take control of your finances once and for all. In fact, many people discover that with proper budgeting they can pay their way out of debt and start saving without taking on new loans or getting into further debt.

If you do opt for debt consolidation or a credit card balance transfer, remember that budgeting will be the key to reducing your debt as quickly as possible.

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