Consolidation LoanDebtDebt Counselling

How Does Debt Consolidation Work?

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The term debt consolidation is well known among those with lots of credit. Often, when debt gets out of hand, consolidation seems like the best solution. The concept is simple. Instead of paying 8 or 9 different credit providers, replace this with one simple monthly payment.  Sounds simple enough right? Let’s look at how to consolidate your debts.

There Are Two Ways To Consolidate Your Debt

In the market there are currently two ways in which a consumer can consolidate their debt:

  • A debt consolidation loan
  • Debt counselling

a. The Infamous Consolidation Loan

A consolidation loan is often misinterpreted as a debt management tool or solution. In fact, a debt consolation loan is just a large personal loan that you would presumably use to pay off all other small debts. In reality, these loans are often used partially to pay off a few debts and the rest gets spent on luxuries or other unnecessary expenses.

Over the past few years these consolidation loans have become more and more difficult to qualify for. Firstly, they are high risk loans, as they are often granted to those that already have a substantial amount of debt. Secondly, they often get used for the wrong reasons and end up making the problem worse by increasing the consumers total debt installments.

Consolidation loans have strict qualification criteria:

  • A high credit score is needed
  • Little to zero arrears on accounts
  • Must have affordability

The strict criteria is often the reason that many consumers don’t qualify for this ‘debt solution’.

b. The Debt Counselling Route

The other way to consolidate debt is through the formal debt counselling process. A debt counsellor will negotiate with each credit provider to reduce monthly installments and interest rates. The result is that you are left with one, lower monthly installment.

To qualify for debt counselling, you need to be over-indebted as well as be able to afford the minimum monthly installment. The debt counsellor also provides the consumers with legal protection against their creditors.

The Difference Between The Two Options

A debt consolidation loan is used to settle all existing debts and be left with just one loan. In essence, the outstanding debt amounts are consolidated.

Under debt counselling, all the original debts still exist. Instead, the debt counsellor negotiates with each creditor to reduce the payments and then facilitates the new monthly payments to each of them. In this case the monthly installments get consolidated into one payment. The debt counselling process and debt counsellors are governed by the National Credit Regulator (NCR).

As mentioned before, consolidation loans are effectively larger personal loans whereas debt counselling is a formal, legal debt management solution. The other main difference is that over-indebted consumers most probably won’t qualify for the consolidation loan whereas you need to be over-indebted to make use of debt counselling. In most cases, a consumer should therefore qualify for one or the other, not both options.

There are also differences in the costs, durations and other consequences of each of these solutions.

For more information on consolidation solutions or anything else debt related, fill out our call-back form for a free financial advice.

 

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