Consolidation loans can worsen debt trap
Do you realise that 90% of your salary is going to paying your debt, leaving you with only 10% to survive — and you still have to buy food, electricity and water?” Asking that question of “Miriam” was Freddy Kamutiba, DebtBusters’ top financial consultant, who took her call this week on the floor of DebtBusters’ huge call centre in Cape Town.
I’d been invited to listen in on several of these calls; calls which had clearly taken those on the other end of the line a lot of courage and commitment to make. Like many who are horribly over-indebted, Miriam hadn’t really interrogated her numbers: all she knew when she made that call to the country’s largest debt counselling company was that “my debt has got too much”.
A 39-year-old state employee, she’s divorced, with two sons — one adult and the other school-going — all living with her parents. She earns a net salary of R11,800 and she’s trying to service a total debt of R485,000. Miriam’s biggest problem is the consolidated loan she took out last year in an attempt to deal with another loan she’d taken out the previous year.
The second loan, of R158,000, is costing her R5,856 a month over a five-year term. With a few taps of his keyboard, Freddy tells Miriam that in the previous 10 months she’d paid R58,000 in repayments for that consolidated loan, but her debt has only reduced by R12,000. “So, in just 10 months, that debt has cost you R46,000,” he says. He tells her, kindly but firmly, she’s made her situation worse.
“The interest rate for the second loan is even higher than the first. You should not be paying 28% interest, because you are over-indebted.”
It’s a subject which Freddy can claim to be an expert on. He has a masters degree from Stellenbosch University, his thesis titled “Investigating the Appropriateness of Consolidation Loans to Mitigate Household Over-indebtedness in South Africa.”
He was studying while holding down his job at DebtBusters, which provided him with ample research material. “Research shows that an increase in unsecured credit is not directly related to consumption and economic growth, but to the use of credit to pay credit through consolidation loans,” Freddy concluded in his thesis. “Consolidation loans are driven by aggressive marketing that takes advantage of naïve consumers.”
In his research he sampled 50 consolidation loanseeking consumers, 10 financial consultants from IDM Group (which DebtBusters forms part of) and analysed consolidation loan marketing messages on credit providers’ websites.
“The results indicated that consolidation loan practices constitute predatory lending, which exacerbates household over-indebtedness,” he concluded.
The marketing of these loans over-emphasises the benefits of consolidation loans while downplaying the downside. “Consolidation loans cause more debt, not less, because they result in new costs, and higher interest rates ... increases in the terms of payment, and they affect affordability over a long period of time,” Freddy found. And Miriam was a perfect example of that scenario.
“Legislative reforms are required to prevent predatory lending and improve debt literacy and household budgeting,” he recommended. Back in the call centre, Freddy is not only working on a proposal to slash Miriam’s consolidated loan interest rate to a single-digit figure but coaching her on practical ways to cut down on her expenses, too. He asks her how she buys her electricity. “It’s prepaid,” she says. “I buy vouchers every few days.” Gently he tells her she’s paying too much that way.
“Rather buy for the month in the first five days of the month.” Sage advice; if you buy towards the end of month, it’s assumed that you intend to consume the lot before the end of the month and thus you’re charged the highest tariff — in other words, you get fewer units of electricity for your spend. Freddy also encouraged her to buy goods on lay-by.
That’s also an excellent tip, for consumers across the spectrum. Even Woolies is punting lay-by as a payment option these days. The downside for consumers is you don’t get your hands on the goodies until after you’ve paid for them in full, but the upside is you pay no interest, and you’re legally entitled to cancel at any time, for no reason, and get almost all your money back.
Legally, retailers can only deduct a cancellation penalty of 1% of the retail price of the goods, which makes this a really low-risk, clever way to buy something. Especially if the goods aren’t needed immediately, for example, winter clothing put on layby months before temperatures dip.
Miriam agreed to go under debt review, in terms of which she’ll pay a reduced amount to settle her debts.
It’s going to take her five years to be free of them, and she will be barred from taking any form of credit during that time, but she’s looking forward to the relief. “I got paid yesterday,” she tells Freddy, “and I’ve got no money left today. I can’t do what I want to …”
The National Credit Regulator revealed this week that 36% of South Africa’s 27.5-million credit-active consumers were “not in good standing” by the end of 2023. That means 9.8-million people are more than three months in arrears with their repayments, have adverse listings on their credit records or judgments and administrative orders.
The results indicated that consolidation loan practices constitute predatory lending