When most people think of consolidation loans, they immediately think of rolling all their debts into one new loan in order to reduce their monthly repayments. While there are distinct advantages to consolidating outstanding debts, perhaps one of the biggest is the ability to begin building wealth.
Consolidating to Get Rid of Inefficient Debt
Carrying unpaid personal debt could stand in the way of building real wealth for your future. Personal debt is the type of debt that is inefficient.
For example, a personal loan for the family car or a credit card with an unpaid balance carried over from month to month is inefficient debt. You can’t claim those debts as tax deductible expenses. Instead, the simply drain money from your budget each month.
Choosing to consolidate those inefficient debts allows you to potentially reduce the amount of interest you pay each month. When you look closely at the interest rate charged to your outstanding credit card debt, you might be surprised to learn that you’re paying as much as 20% p.a.
It might also surprise you to learn that the minimum monthly repayments the bank ask you to pay won’t help you get rid of that debt any time soon. Rather, the minimum repayment covers the interest charged, plus a very small amount that gets paid off your outstanding balance.
By comparison, rolling your personal debts into a consolidation loan allows you to reduce the interest you pay, so you’re saving money. A lower interest rate may also translate to reduced monthly repayments overall.
Repayments on consolidation loans are also calculated differently to how minimum payments are set on credit card balances. Your consolidation loan is amortised, so each payment consists of a component to cover the interest and another component that reduces the outstanding balance.
Smart Strategies for Using Debt to Build Wealth
Once you’ve rolled your inefficient personal debts into a more effective consolidation loan, you can take advantage of the changes to your financial situation. As your minimum monthly repayments are lower, you can use the savings you made to put towards reducing the debt more quickly.
When your personal debt is out of the way, you also have the opportunity to start focusing on building wealth. There are several strategies you can use to build wealth.
• Pay the money you save off your home mortgage. As you reduce your mortgage balance, the amount of equity you have increases.
• Create an emergency fund. One of the key reasons many people end up with unpaid credit card debts is that they don’t have enough savings to cover emergency expenses. Make a decision to put some money aside into an emergency fund, such as an interest-bearing savings account or into your mortgage offset account or perhaps into your mortgage to be redrawn later as required.
• Leverage your equity. As you build up equity in your family home, you have the option of leveraging that equity to use as security to purchase an investment property. Likewise, if you’ve put your cash savings into your mortgage, you can also redraw those funds to put towards paying a deposit on an investment property.
Personal debt can hamper your ability to build wealth for your future. Rather than allow your outstanding personal debts to hold you back from achieving your goals, consider how a consolidation loan might help you get further ahead instead.