Most South Africans that have loads of debt have heard of debt consolidation. Whether through talking to credit providers or friends or by seeing pop up ads on social media and online, debt consolidation is made out to be the silver bullet when it comes to managing debt.
Consumers with vehicle finance, multiple personal loans, a few credit cards and store cards and a couple of payday loans think that consolidating all this debt is the answer to debt freedom. The truth is that it is much more complicated than that. For some individuals, debt consolidation may be a great option but for others it may not be viable at all.
What Is Debt Consolidation?
A debt consolidation loan is a large personal loan granted and used to pay off smaller debts. Anyone with a good credit rating and is up to date with debt repayments can try get a consolidation loan.
Debt counselling is a formal debt solution. A debt counsellor will formally negotiate with credit providers on behalf of the client to reduce monthly instalments and calculate a new payment plan. Only consumers that are over-indebted (income is not enough to cover debts and living expenses) may qualify for debt counselling.
Three Common Misperceptions
1.) Debt Consolidation Is A Quick Fix
Debt consolidation is needed because current debt repayments are too high. In order to reduce these instalments, the term of the debts need to be stretched out. Consolidation loans are usually taken out for 36-60 months. Consumers will still have access to other debts so need to be disciplined in order to become debt free.
Debt counselling will aslo stretch out the terms to 36-60 months. Under debt counselling, however, the consumer will not be able to access any new credit. This forces the consumer to live within their means and make sure they settle all their debt.
Of course the consumer can pay more each month under both options which will result in reducing the time periods to pay back the debt.
2.) Your Debt Gets Reduced Through Using A Debt Consolidation Loan
Some people believe that using a consolidation loan to pay off debts will reduce how much you owe. This is incorrect. A debt consolidation loan is merely a large personal that is used to pay off your other debts. It is usually a longer-term loan, which will reduce the monthly instalments but not the amount you owe.
Let’s say you had R90,000 worth of debt and got a debt consolidation for R90,000. You would use the money to pay off the smaller debts and only be left with the large R90,000 loan to repay. This loan will still have interest and fees that need to be paid. Because the consolidation loan is over a longer period, the interest and fees are usually quite high.
With debt counselling, however, the debt counsellor will renegotiate the payment terms. What this means is that they propose new terms to all credit providers because the client is currently over-indebted. Debt counsellors are able to negotiate lower interest rates and effectively save the client lots of money. This is one of the biggest benefits.
3.) A Debt Consolidation Loan Is The Only Debt Solution Out There
Debt consolidation loans are very attractive for people with lots of debt. The trick is that they are quite difficult to qualify for. For those consumers who have lots of debt but are easily able to pay their debt on time and in full each month, this may be a fantastic option. For those with so much debt that they a struggling to juggle all their payments, it may not be.
To qualify for a consolidation loan you will need to tick a few boxes. Firstly, you must be up to date with all existing debts. Secondly, you must have affordability, i.e. the ability to pay back the new loan. Lastly, your credit score needs to be really high.
For over-indebted consumers, consolidation loans are not an option due to these qualifying criteria. It is best for over-indebted consumers to chat to a debt counsellor about debt counselling. Consolidation loans are not an option due to affordability issues.