How to Calculate the Real Cost of Debt Consolidation

Let’s say you have three credit cards. One has an 18% interest rate on ₹50,000, the second charges 22% on ₹30,000, and the third applies 25% on ₹20,000. 

That’s ₹1,00,000 in total debt, and you’re struggling with high monthly payments. A debt consolidation loan offers to combine all three into one loan at a lower interest rate, say 12%. Sounds like a relief, doesn’t it?

In India, credit card interest rates typically range from 23% to 49% per annum, depending on the issuer and the cardholder’s credit profile.

But what about processing fees and loan tenure? Let’s break it down and see if it’s worth it.

What Is a Debt Consolidation Loan?

A debt consolidation loan is a way to combine multiple debts into one loan with a single monthly payment. It often comes with a lower interest rate. 

But here’s the kicker: these loans can stretch repayment over a longer time. This means you could end up paying more overall, even if the monthly payment seems manageable.

So, is it a smart choice? It depends. Let’s break it down.

Example:

Imagine you owe ₹1,00,000 on your credit cards and opt for a debt consolidation loan at 12% interest over 5 years. The monthly EMI would be ₹2,224. 

But over 5 years, the total repayment would be ₹1,33,440, which includes ₹33,440 in interest.
Now compare that to paying off your credit cards at the current rates in just 3 years. Would the savings justify the switch?

The Real Costs: What to Watch For

Debt consolidation loans often come with hidden expenses. Here’s what you should calculate:

Pro Tip: Always check the Annual Percentage Rate (APR), not just the interest rate. APR includes fees, giving you the true cost.

Key Factors to Consider

When choosing a debt consolidation loan, think long-term. Ask these critical questions:

• How much will I save overall? Use a calculator to compare.
• Can I commit to the EMI? Missing payments affects your credit score.

Here are six quick points to remember:

1. Calculate the EMI using online tools.
2. Compare APR from multiple lenders.
3. Check for prepayment flexibility.
4. Avoid extending tenure unnecessarily.
5. Look for zero or low processing fees.
6. Keep emergency funds intact for unexpected expenses.

Example Scenario

You owe ₹1,50,000 across three personal loans:

• Loan 1: ₹50,000 at 14% for 2 years.
• Loan 2: ₹50,000 at 18% for 3 years.
• Loan 3: ₹50,000 at 20% for 4 years.

By consolidating into a single loan of ₹1,50,000 at 12% for 5 years, your total repayment becomes ₹1,99,680. While the monthly payment reduces, the total cost increases. Run the numbers to know what works best for you.

Alternatives Worth Considering

Debt consolidation isn’t your only option. Here are other strategies:

• Debt Snowball Method: Pay off smaller debts first, regardless of interest rate.
• Debt Avalanche Method: Focus on high-interest debts first.
• Balance Transfer Credit Card: Ideal for short-term repayment plans with low promotional rates.

Each option has pros and cons. Explore these based on your financial health.

Conclusion: Think Beyond Monthly Savings

Debt consolidation loans promise simplicity, but the real cost depends on your diligence. Always look beyond the interest rate. Calculate the total repayment, including fees and tenure impact. Use online tools to compare options.

Here’s a parting thought: Would you rather save ₹500 on monthly payments or ₹50,000 over the entire loan term? Let that guide your decision.

FAQs

1. Is a debt consolidation loan always cheaper?
   No. It depends on the interest rate, tenure, and fees.
2. Does debt consolidation hurt my credit score?
   Initially, yes, due to a hard inquiry. But consistent payments improve it over time.
3. What fees should I check for before signing up?
   Processing fees, prepayment penalties, and GST are common.
4. Can I consolidate secured and unsecured loans together?
   Not usually. Lenders prefer unsecured loans like credit cards and personal loans.