Every now and then, taking on a bit of debt seems like a good idea. You simply must have that jacket, but you don’t have the cash. You need a new sofa, but you haven’t saved up. Or you’re struggling to get to the end of the month, so you just dip a little deeper into your credit card. Before you know it, all these “manageable” debts add up, and you find yourself owing thousands of Rands at the end of every month with, it feels, decreasing hope of ever paying it all back.
One approach to managing debt that starts to get out of control is to consider debt consolidation, which involves combining all your debts into one bigger loan and then paying back only that one loan amount – which will help you to manage your financial obligations with more focus and attention. We chatted to Kim Armfield, an attorney and debt counsellor at Libertine Consultants, to understand more about the process.
What is debt consolidation?
“Debt consolidation can be one of two processes,” says Kim. She explains that you can either take out a consolidation loan (usually through a debt consolidation provider) or you can opt for debt review, which is a legal process in which a debt counsellor handles the consolidation for you.
If you have opted for a debt consolidation loan, you can use it to pay back your debts in full and then pay the loan provider one monthly repayment.
If you have opted for debt review consolidation, your debt counsellor will assess your outstanding debt and negotiate with all your creditors to arrange a reduction in interest rates or a term extension. Each month, you will pay the debt counselling organisation one monthly instalment, and they will pay the renegotiated amount to each of your creditors.
Either way, the outcome is the same: instead of many debts, you are now servicing only one. In most cases, the term of the debt is extended beyond the term of each of the original debts, so the total repayment ends up being lower which makes it more manageable and the pay off more attainable.
debt consolidation is not getting rid of your debt, it is simply replacing it with a more manageable option
“Whichever of the two options you choose, debt consolidation does not mean that you are just getting rid of your debt, it is simply replacing it with a more manageable option,” says Kim.
How does debt consolidation affect my credit record?
A consolidation loan will not affect your credit record. You will still be able to take out additional credit, although you should avoid this at all costs while you are paying off your consolidation loan, says Kim. Don’t overextend yourself – rather focus all your money available on servicing and clearing your existing debt obligation.
Debt review is a process that you enter into because you can’t manage your debts, and this will reflect on your credit record. This means you will probably not be granted new lines of credit – including a home loan or car finance – and you may even be denied services like rental or school admission.
“If you choose a debt review consolidation, then this will reflect at the credit bureaux and you will not be able to obtain credit while under debt review,” says Kim. After the debt review process and when your debt is repaid, you will be able to clear your credit record and take out new lines of credit.
How do the multiple interest rates get consolidated?
When you take out multiple lines of credit, the interest rates will differ depending on the type of credit and your risk profile. But when you consolidate your debt, you’ll be charged a single interest rate by the consolidation provider.
“A consolidation loan is a higher risk loan - you are considered more likely to default because of your past over-indebtedness - so you will usually be charged a higher interest rate. But your monthly instalments will be lower because of the longer term of the debt,” says Kim. “In the case of debt review, your debt counsellor will negotiate a lower interest rate with your credit providers, so you do actually end up paying less back.” But don’t forget that debt review will appear on your credit record.
Who provides debt consolidation?
“Some banks, some specialist debt providers and some debt counsellors offer debt consolidation in the form of a credit agreement – which is a loan that covers all your other lines of credit,” says Kim. “Debt counsellors provide debt review.”
How do I qualify for debt consolidation?
The qualifying criteria for debt consolidation, whether you are doing loan consolidation or review consolidation, is affordability, says Kim. “The credit provider or debt reviewer will work out whether you can afford the amount necessary to ultimately settle your consolidation loan or your debt review instalment.” This assessment will determine whether you qualify for debt consolidation.
What are the benefits of debt consolidation?
Your debts become more manageable and affordable, as you are paying one monthly instalment rather than a number of them, and usually over a longer term.
What are the drawbacks of debt consolidation?
The extended period that you are given to pay back the credit means that you will be servicing the debt for a much longer time.
If you have taken out a consolidation loan, your interest rate will be higher, which means that in the end, you will have paid back a greater total than you would have on the original debts.
If you have gone through debt review consolidation, your interest rates will probably be renegotiated for you, but the process will reflect on your credit rating, which will prevent you from taking out further credit. “But if you truly want to get out of debt and live debt free, this is not necessarily a bad thing,” says Kim.
Don’t do debt
The easiest way to avoid having to consolidate your debts is to avoid debt in the first place. Certainly, don’t take out multiple lines of credit with various different providers, or the situation will soon spiral out of control. But if you’ve let your credit situation get a little out of control, debt consolidation is a helpful approach that will make your repayments more manageable.
If you need debt consolidation, approach the National Debt Counsellors Association of South Africa, who will be able to provide you with a list of reputable and ethical members who can assist you with making the right decisions with regards to taking steps to your own financial future.