How to consolidate multiple loans

We consolidate multiple loans and advances if we want to achieve two effects:

  1. reduce your total monthly payment
  2. pay for the repayment period less on interest

However, we do not always achieve both effects at the same time. Sometimes we may reduce our total monthly installment, but in the end we pay much more for the repayment period than if we did not consolidate the loans. Conversely, we can consolidate loans by paying more efficiently (we pay less on interest), but the total monthly installment may increase over a period of time.

The main factor affecting both the repayment and the sum of the interest paid is the maturity of the consolidated loan.

The following table shows how the repayment of two types of loan can look like:

Type of loan Credit balance (principal) Monthly installment Number of years to maturity Interest rate Amount of interest paid
Consumer loan 100.000 USD 1.321,51 $ 10 10% 58.581,20 $
Credit card 50.000 USD 2.068,18 $ 3 28% 24.454,48 $
Total 150.000 USD 3.389,69 $ 83.035,68 $

Consumer credit has a much lower interest rate, has a 2 times higher principal and more than 3 times longer maturity than repayment of the spent credit card. Although the monthly repayment is lower for a 2-fold higher loan, the distribution of the repayment over a longer period will cause the client to overpay a much higher amount on interest. This repayment of the loan is financially effective because the client will get rid of the loan with a high interest rate. Although he will have to withstand a higher installment for a certain period of time, but after 3 years his monthly cash flow will improve and he will only have to repay one loan.

Let’s look at two consolidation offers for this client

(1) The loan in the amount of 150 ths. USD, maturity 10 years, interest rate 9% pa

Type of loan Credit balance (principal) Monthly installment Number of years to maturity Interest rate Amount of interest paid
Consumer credit (consolidation) 150.000 USD 1.900,14 $ 10 9% 78.016,80 $

(2) The loan in the amount of 150 ths. USD, maturity 7 years, interest rate 7% pa

Type of loan Credit balance (principal) Monthly installment Number of years to maturity Interest rate Amount of interest paid
Consumer credit (consolidation) 150.000 USD 2.263,90 $ 7 7% 40.167,60 $

If the client concentrates only on the greatest monthly savings on the installment in the first years of repayment, then it is more convenient for him to choose the offer No. (1). However, it should be borne in mind that he will repay less than USD 1,500 in the first three years, but in the next seven years his repayment will be USD 600 less than if he had kept the original two loans. The total interest paid shows that in the 10-year horizon, savings of only about 5,000 USD.

The second offer of consolidation we see a slightly different situation

The second offer of consolidation we see a slightly different situation

The loan is cheaper (7% pa), but also has a shorter maturity (7 years). Both of these factors will positively affect the financial cost of the loan (ie what we pay extra). We see it in the column “sum of interest paid”. Compared to the original two loans together, the client overpaid by about 43 thousand. USD less and compared to the offer of consolidation no. (1) by 38 thous. USD less. However, this savings is offset by the fact that the client must accept slightly higher monthly payments. In the first 3 years it will save 1,100 USD, in the next 4 years it will pay about 900 USD more and then the loan will be repaid (compared to the original two loans it will still save 1,332 USD per month for the next 3 years).

What are the consolidation recommendations?

money saving

As can be seen from the described examples, no conclusion is quite clear and it always depends on which priority the client prevails. If the client needs to bridge a short period (eg 2 – 3 years), when – as they say – counts each crown, then he can choose a loan with longer maturity in order to reduce repayments as much as possible. Once its situation has improved, it should consider whether it will not finance the loan for a loan with a shorter maturity or make extraordinary installments.

However, if the client focuses from the outset on paying as little interest as possible, the client should choose a shorter loan maturity.

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