Consolidation loan or the concept of debt consolidation in general is a process of taking one single loan to replace multiple loans or a loan with high interest rate (for example credit card debt). This can effectively help to reduce total cost from high interest rate or finance charge.
As mentioned previously, consolidation loan is useful for replacing one or multiple high interest loans which may include:
- Finance charge on credit card debt (if you do not pay credit card on time)
- Finance charge on credit card cash advance (if you withdraw cash using credit card and do not pay on time)
- Overdraft facility
Interest expense from these types of borrowing can be high as they tend to have high interest rate (up to 30%+ APR) or their finance charges accrue on a daily basis.
Benefits of consolidation loan and who it is suitable for
In general, consolidation loan provides the following benefits:
- Reduce total interest expense and finance charge. Given total loan repayment amount is a combination of principal and interest expense, this will help to reduce overall loan repayment so that you can pay off your debt earlier or reduce burden on your monthly cashflow
- Simplify payment process. Keeping track of and paying for a single loan is simpler than doing so for multiple loans. More importantly, it also reduces the risk of missing repayment (which can help you to avoid various finance charges)
Consolidation loan tends to have lower interest when compared to other more expensive types of borrowing listed above. So how do you know if consolidation loan is right for you?
- You are paying for one or more high interest loans
- You still have a good enough credit score to qualify for loan with lower interest than your current ones
- Your cashflow in the next 12 – 36 months will allow you to pay off the new consolidation loan
Illustration of how consolidation loan can benefit you
In this example, we will be looking at a consumer who is paying for one credit card debt and one overdraft facility every month, however both loans are accruing interest on a daily basis.
| Credit card debt | Overdraft facility | |
| Outstanding balance | HK$40,000 | HK$150,000 |
| Interest | 25% APR accruing daily | 15% APR accruing daily |
| Current monthly repayment | ~HK$7,170 | ~HK$9,370 |
| Total interest expense | ~HK$3,000 | ~HK$18,550 |
| Est. time until total repayment | 6 months | 18 months |
Following the above calculation, this consumer is spending HK$16,540 in loan repayment every month. It will take about 18 months for all debt to be paid back and total interest expense during this period will be HK$21,550.
If this consumer is to take a consolidation loan of equal balance with similar monthly repayment amount however, the consumer will be able to reduce interest expense as well as become debt-free sooner.
| Existing loans | Consolidation loan with 10% APR which accrue monthly for 12 months | |
| Balance | HK$190,000 | HK$190,000 |
| Monthly repayment | HK$16,540 | HK$16,704 |
| Total interest expense | HK$21,550 | HK$10,450 |
| Est. time until total repayment | 18 months | 12 months |
This example illustrates how consolidation loan can help a consumer who is paying for multiple high interest loans by reducing total interest expense and repayment timeline while keeping a similar level of monthly repayment amount.
*Note: calculations above follow a standard formula and may differ from calculations used by financial institutions
Things to watch out for before taking a consolidation loan
While the benefits of taking a consolidation loan can be quite clear, there are still a few things to take into consideration:
- Like any other types of loan, consolidation loan requires timely repayment. Missing of payment can lead to additional interest and finance charge
- If high monthly repayment will place a burden on your cashflow, consider a consolidation loan with longer repayment (Although this will lead to higher overall interest expense. Read more about the relationship between repayment plan and total interest expense here)
- If your existing loans’ outstanding balances are small enough and you have enough saving for emergency situations, paying off the loans or making early repayment could be a better alternative than consolidation loan (However do watch out for early repayment fee)
It is advisable that you do research and plan ahead of any borrowing. If you are looking for more resources around borrowing, feel free to visit the Investor and Financial Education Council or the Chin family’s website.
