Combining debt is no silver bullet
Do the sums on debt consolidation; don’t incur more interest
● For anyone struggling to pay multiple creditors — all charging admin fees and credit life insurance and fluctuating interest rates — a debt consolidation loan may seem the perfect solution.
One creditor, one payment every month equals one headache versus many. Right? If only it were that simple. If you don’t have your wits about you, a debt consolidation loan can incur more expensive debt.
Debt consolidation must result in a reduced total monthly debt repayment to credit providers, says Jeroen de Lijster, executive director of Edubond, which provides debt consolidation for government employees. “There needs to be a significant monthly cash-flow benefit to the client, without the client incurring more debt.”
Lenders can do this by negotiating a discount on your debts for early settlement and by offering you a lower simple average interest rate than you are paying your creditors. A simple average interest rate ignores the weighting of your various debts — whether you are paying 13% interest on a tiny debt, or 3% interest on an enormous one.
Lenders also extend the repayment period, which may mean you pay more interest over the longer term.
For debt consolidation to work for you, make sure you do the sums — and your homework. Understand what your debt is costing you. You may know what you’re paying creditors every month, but do you know how much of that consists of interest and fees? And whether you would be eligible for a debt consolidation loan? If so, what interest rate would you be charged? Debt consolidation is not only about simplifying your finances — it’s about improving your monthly cash flow and paying less interest, if possible.
Say you owe R1-million on your home loan, R220 000 on your car, R15 000 on your credit card, R5 000 on each of your store cards, and R5 000 on a short-term loan, and your total debt is R1 250 000. Your monthly instalments, excluding admin fees and credit life cover, would be about R10 500 for your home loan (at an interest rate of 11.25%), R5 330 for your car repayments (at 15% interest), R1 375 for your credit card debt (at 18%), R930 on your store cards (20.75%) and R845 for the short-term loan (5% a month over six months and 3% a month for subsequent short-term loans taken in the same year, therefore 48% a year).
If you include your home loan, your average interest rate is about 23%. Since the maximum debt consolidation loan on offer is R250 000, you would have to exclude your home loan. This takes your average interest rate up to about 25%.
Debt consolidation loans are unsecured and attract a maximum interest rate of 27.75% (repo rate plus 21%). Unless you qualify for less than the maximum rate, debt consolidation is going to cost you more in the long run, so it doesn’t make sense to consolidate your debt using a personal loan.
Do not go with the first credit provider to offer you a loan. Shop around for the best rate. If you have a good credit record and score, use this to negotiate the best rate.
Sbusiso Kumalo, head of brand marketing at Capitec, says the bank is offering qualifying customers unsecured loans from as little as 12.9%.
Eunice Sibiya, head of consumer education at FNB, says most consumers don’t know what interest they are paying on their various credit agreements. So they don’t know a good rate from a bad one. “If you have a bad credit record, you have no muscle to negotiate a good rate.”
De Lijster says consumers must ensure their credit provider is s registered with the National Credit Regulator. Check the NCR website (ncr.org.za) for the credit provider.
Don’t be too quick to consolidate. Critics of debt consolidation describe it as “debt displacement” because instead of eliminating debt, you move it.
Sibiya says it is important to interrogate what brought you to the point of seeking debt consolidation. Unless it is a change in circumstances such as a pay cut or something beyond your control, you need to acknowledge your mistakes. There may be a DIY solution: “Consider cutting back on luxuries, or cutting out behaviour that is costly, like dining out.”
De Lijster says it is important to understand why you are seeking debt consolida-
tion. “If you’ve taken out expensive loans to buy luxuries, this is a red flag. Understand the cause of your overspending and deal with the root by speaking to someone about the real issues in your life.”
Use your home loan to consolidate your debt, if you can. For most people it is their cheapest credit, because it is secured by an asset.
The most interest a mortgage lender can charge is the repo rate plus 12%, or 18.75% at the prevailing repo rate. But most people pay the prime rate (10.25%) plus 1% or 2%.
You can only use your home loan to consolidate your debt to the extent that you have equity in the property. This means you can only borrow against what you have already paid off and up to the market value.
When using a home loan to consolidate debt, it is vital that you don’t pay off your short-term debt over the life of your home loan, because that defeats one of the key purposes of consolidating: saving on interest. The big risk of using your home loan to consolidate is if you default. Defaulting on your home loan can lead to you losing your home.
If you go the unsecured loan route, make sure you use the debt consolidation loan to pay off as much of your debt as possible.
When done properly, debt consolidation will improve your cash flow. If you find you have a little extra at month-end, use it to pay down your debt faster, Sibiya advises.
Perhaps the golden rule is not to take on more debt until your debt consolidation loan is paid off.