When to consolidate your debt

TK wants to know if debt consolidation is a good option

Maya replies: Debt consolidation can reduce your debt repayments BUT only if you do not use it to access additional debt.

Debt consolidation is a process where you take out one loan to settle your many debts and then you only have to focus on paying off this single loan, rather than dealing with many different credit providers.

How you do this depends on your needs:
Looking to cut interest rate costs: You can pay off short-term debt using your mortgage to take advantage of the lower interest rates. But this only works to your advantage if you continue to pay off the debt at the same rate.

In other words if you are paying off your credit card make sure you make the same repayments into your bond as you would have made into your credit card. Don’t just pay the minimum you need to pay into your bond otherwise you end up paying off your credit card over 20 years which is very expensive.

Struggling to make payments: If you are struggling to meet repayments on several different loans, you can go to the bank and take out a single loan over a slightly longer period resulting in a lower monthly repayment. You then settle the various outstanding loans immediately and concentrate on paying off the single bank loan. Just make sure you pay off this debt and do not take on further debt.

Under no circumstances use bridging finance or cash loans for consolidation - these can be extremely expensive and are also not always regulated by the National Credit Regulator.

How it works:
If, for example, you owe R16 000 to your creditors, this is how consolidation will work.
- You owe R3 000 to a clothing store (at a monthly interest rate of 25%)
- You owe R3 000 to a second clothing store (at a monthly interest rate of 25%)
- You owe R10 000 to a service provider (at a monthly interest rate of 30%)
The average interest you are paying monthly is 26%.

You can now ask for a loan of R16 000 to cancel your debt and in the process you can negotiate a lower interest rate of perhaps 20%.

Now, each month, you will have an extra R200 or R300 in your pocket, which you should use to cancel the debt more quickly.

It is also important to ensure that the cost of debt consolidation is less than current cost. In some cases, a short-term consolidation product increases cost for the consumer due to administration fees. Debt consolidation is therefore usually only beneficial for longer term loans of more than six months.

Be aware:
- You could have your assets or property attached if you fail to make your repayments.
- Negotiate a reasonable repayment period as the longer you take to pay, the more you’ll have to pay in interest.
- If you pay at a fixed rate, it may be set higher than if it were not fixed, to cover the bank in the event that the interest rate goes up. However a fixed rate does allow you to budget more easily as you know there will be no interest rate surprises.
- Consumers may take advantage of the loan to spend money and get into more debt. The key here is financial discipline.
- Debt consolidation treats the symptoms of the problem, not the cause. You have to look honestly at how you landed up in financial difficulty in the first place and put in measures, like budgeting, to ensure that you do not go back into debt.

Read more news, blogs, tips and Q&As in our Smart Money section. Post questions on the site for independent and researched information.

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