The logic of debt consolidation is that the debt is in one loan and is being charged a lower interest rate than if it were spread over a number of providers. As an example, consider a household with $50,000 remaining to be paid on their mortgage at 7%. There’s also a $10,000 car loan at 10% and a $10,000 credit card debt at 14%. With three separate loans at three separate rates, the household is paying $3,500 annual interest from the mortgage, $1,000 from the car loan, and $1,400 from the credit card, for total interest charges of $5,900 or 8.4%. But if this household can roll all $70,000 into the mortgage at 7%, the total interest charged falls to $4,900 for a saving of $1,000, or 1.4%.
By rolling the car loan and credit card debt into the mortgage, they are reclassified as secured loans. This lowers the interest rate, as secured loans have a lower default rate and higher discharge rate, and therefore the bank can charge less interest on their reduced level of risk. Also, credit cards are harder to administer, and so rolling the debt into the mortgage lowers the monthly administrative fees, as well.
Another advantage is that the mortgage is paid out over a longer period and so the repayments will be less. However, this does mean that the cumulative interest over time will be higher, as it is spread over a number of years.
There is also the advantage that there will be one payment to be made every month, rather than several. This lowers the chance of a payment being missed or late through forgetfulness.
