It is a common misconception that with debt consolidation your debt will just go away.
It will still be there, but in another form. It will most likely be more affordable to repay and this is the best news. However, you have to take into account the fact that your spending habits will have remained more or less the same as before.
Nowadays it is easy to get into debt given that there are so many things to spend on while income is always limited. One of the main dangers of debt consolidation is the belief that you are free to spend as much as before. This will actually get you into even more trouble. That is why debt consolidation should be accompanied with a change in your spending habits. Your goal is to become more disciplined and to spend less than before.
At the same time, you have to take into account the fact that the lenders that offer debt consolidation are trying to profit as well. You will still have to pay interest and make monthly payments on time. This is yet another reason why you should adopt an effective strategy not only for getting rid of the immediate danger but for getting rid of debt altogether.
There are different types of credit each of which has a different cost. Home loans are the cheapest of all credit forms as the interest on them is slightly above the prime rate set by the South African Reserve Bank. The most expensive forms of credit are the credit cards, short term loans and payday loans which can have annual interest of 32% and possibly higher.
The lower interest rate of home loans makes them suitable for financing major purchases and projects such as buying new kitchen appliances and repairing the house roof. The best strategy here is to repay the additional loan amount as quickly as possible. If you spread the payment over a long period of time, the total interest amount will be very high and you will be on the losing side. There would not be a great difference between this finance option and the use of personal loan with interest rate of 20% and term of 3 years.
The idea behind debt consolidation is simple
All of your credit card and say for eg. personal, FNB loans that you currently have are bundled into a single loan with a single monthly payment and a fixed term. This eliminates the hassle of keeping various deadlines and making various payments. Usually, the interest rate on the consolidation loan is lower compared to the rates on all of your existing loans and lines of credit. This reduces the size of your monthly payment and gives you a higher disposable income.
It's worth looking at home debt consolidation
The lender will take into account the outstanding balance on your home loan and equity that you already own in the property. The size of the equity determines how much more money you can afford to borrow. The other determinant is the total outstanding balance on all of your other loans and credit cards. If the equity which you own in your property exceeds this outstanding balance, you will be able to take advantage of debt consolidation.
The lender will grant you a new loan which is basically a debt consolidation loan. This new loan will be backed by your property. This means that if you default on the payments, the lender may take your house. The new loan will be used for covering your outstanding debt on all personal loans and credit cards. Usually, there is no free cash left for the borrower.
The new loan will have two important characteristics. Firstly, it will have lower interest rate compared to the unsecured loans which you previously held. Its interest will be the same as or similar to that of your home loan. This will automatically result in lower monthly payments and more disposable income for you. Secondly, the debt consolidation loan will have the same remaining term as your bond. This will make the monthly payments even smaller if the bond's remaining term is longer than the terms of the loans which you repaid using the new one.
This will allow you to generate even greater monthly savings.
So far, it seems that you will save quite a lot of money and get more financial freedom. However, this is not exactly the case. The longer term of the debt consolidation loan will make your monthly payment smaller, but it will also boost the total interest amount which you owe. This is because you will have to pay interest for a longer period of time. The best way to actually generate significant savings is to repay the new loan as early as possible by making larger payments whenever you can. For this, you will require careful planning, strict budgeting and perfect spending discipline.
The most serious danger of debt consolidation, as explained earlier, is keeping your previous spending habits. You need to view this financial move as an opportunity to save on interest and not as a way to get some more free cash during the month. If you regard this move as an interest-saving option, you will have the motivation to draft a plan for the earlier repayment of the new loan. In this way, you will have the best chances to save money while staying out of debt trouble.
You must also realize the danger of losing your home if you default on the new debt consolidation loan. This is yet another reason why you should be extra careful about the loan repayment and about your spending habits. If you use the loan wisely, you will make full use of debt consolidation and enjoy maximum benefit. If you are not careful, you may end up in an even worse situation than you were in initially.
The good news is that you can avoid this without much effort.
You should have a precise idea about the main terms used here and by lenders as well. The following definitions will be of great use to you.
This process involves the transfer of debt from various accounts into a single account. It is done for the purpose of saving on interest or for better cash flow management. Effective debt consolidation occurs when the amount of interest paid monthly and the other monthly loan charges incurred are reduced.
2 types of debt consolidation loans – secured & unsecured
Debt consolidation is secured when it is backed by an asset owned by the borrower, typically their house. One example is the second mortgage also known as a home equity loan. The new loan is unsecured when there is no surety placed by the borrower. An example of unsecured loan is the personal loan.
This is a loan secured with an asset. The asset is typically a house or a car. If the borrower defaults on the loan, the asset can be repossessed and sold by the lender for the purpose of recovering the loss. When the loan is secured, the risk for the lender is lower. That is why the interest rate is lower compared to the rate charged on unsecured loans.
Consolidation Loan Availability
In recent years, the South African lenders have been accused of reckless landing and the National Credit Regulator is imposing ever stricter rules on them. In this situation, the availability of consolidation loans is not as great as before. Many of the companies which used to specialize in this type of loan are now referring their customers to regular lenders such as banks and bond companies. Currently, the four largest banks in South Africa do not offer specifically tailored debt consolidation products. Still, if you are a reliable payee with good credit record, your bank may grant you a secured on unsecured loan with lower interest rate which you can use to repay your current debt.
In order for you to access debt consolidation, you need to contact your bank personally. Consolidation loans or ones which can be used as such are available only by request. You have to ensure that you meet the eligibility criteria which include sufficient income and exemplary credit record. The banks explain that their decision to cease offering debt consolidation as a separate product has to do with the fact that that the general high level of consumer indebtedness poses higher risk to them.
At the same time, there are lenders like SA Home Loans that do not consider consumers looking for debt consolidation to be high-risk borrowers. They are able to offer secured debt consolidation to people who are currently repaying their existing debt timely and have no defaults or judgements.
The experts comment that now it is more challenging to find debt consolidation loans with much lower interest rates. Many of the lenders that offer them will actually charge higher interest but will make the term much longer to make the monthly payments smaller. As a result, you will have to pay a much higher interest amount in the end. In this case, this solution is simply ineffective.
Another issue which experts pinpoint is that currently most lenders do not assume the responsibility to repay the existing debt of their clients. This means that the amount granted with the new loan is left with the customer to dispose with. In this case, there is no guarantee that the person will settle the debt. This poses even greater risk of debt issues in the future.
The lenders that arrange debt repayment on behalf of their clients offer this as an optional service. It is certainly recommended that you take advantage of this service. It will make things easier for you and give you peace of mind about the future.
What to Look for in Debt Consolidation
You need to ensure that the debt consolidation loan which you take out meets the following criteria:
- Sufficient loan amount for covering your entire outstanding debt on unsecured loans and credit cards
- Lower interest rate than the average which you currently pay
- Lower monthly payment which is affordable to you given your current monthly income and spending
- Credit life insurance on the loan which is designed to repay it in case you pass away, become disabled and this prevents you from earning an income or you are unable to earn sufficient income for a valid reason
- Fees and other charges associated with the granting of the debt consolidation loan which are affordable and do not offset the reduction in the interest rate
Finally, you must ensure that the debt consolidation loan which you take out matches your long term financial goals. It pays off to devise a financial plan and to stick to it strictly. That way, you will not only manage to repay your debt and save but make all your dreams reality.