Studies have shown that South Africans spend, on average, 63% of their after-tax income on debt. That’s pretty shocking. Spending most of our income on debt means that we have less to spend on the things that matter most. While consolidation loans may seem like a great idea, the long-term effects are not worth it.
The main reason for consolidation loans being so popular is the way they’re being sold.
Credit providers are selling you false hope just to make a few more bucks along the way.
What is a consolidation loan?
Consolidation loans allow you to combine all your different loans and pack them into one new loan. Once you consolidate all your debt in another loan, you’re left with only one loan amount.
Most institutions will try and give you the loan at a lower interest rate with extended repayment terms. And you only have to make a single debt repayment.
To put it simply. You’re repackaging all your debt into a neat little box while paying a lower interest rate over a longer period.
Here’s what a typical consolidation loan looks like;
- Only make one monthly instalment
- Save on interest
- Pay less on monthly instalments
- Extend your repayment plan
- You’re less likely to miss repayments
To be honest, this does sound pretty good. Who doesn’t want to pay less on their monthly debt repayments?
But, consolidation loans are not as great as it may seem.
And here’s why…
Lower interest rates are not guaranteed
Most companies will imply that they can offer you a lower interest rate. The truth is, it’s not guaranteed. You’ll have to qualify for the lower interest rate like any other loan.
Your loan interst rate is determined by your credit score.
But even with a lower interest rate, it doesn’t mean you’ve struck a good deal. You’ll end up paying more in interest because you’re taking longer to pay off your debt.
You’ll be in debt for longer
Companies who sell the consolidation loan dream can offer low monthly instalment fees because they’re extending the loan period.
For example, instead of paying all your debt off in 3 years, now you’re paying it off in 7 years.
Extending the loan period will naturally decrease the monthly repayment. This might sound like a good idea. But this does not put you in a better financial position.
Extending your debt repayment term is crazy. Your goal should be to eliminate your debt as soon as possible.
Extending your loan period puts you in debt for longer and will end up costing you more as well.
Debt consolidation doesn’t solve the problem
Debt consolidation does not mean you’re guaranteed debt elimination.
The real problem is behaviour. You haven’t learnt good money management skills and habits. If your behaviour doesn’t change, the chances are high that you’ll end up making more debt in the end.
The reason for this is that you don’t have a game plan.
If you want to succeed in eliminating debt and becoming debt-free, you need a game plan or a strategy. Without an end goal, you’ll struggle to eliminate your debt and never build real wealth.
Most people think they’ve struck a good deal with a consolidation loan because they have a little extra money each month. But the majority of people spend that extra money recklessly. They either end up making more debt or spend it on things they don’t really need.
As a result consolidation loan does not help you understand how to manage your money wisely and could send you in further debt.
What a consolidation loan really looks like?
Let’s break it down with an example.
Paul is struggling to make ends meet and he needs some financial support. Paul is on a mission to find the best solution for his current financial situation.
Paul has R315 000 in unsecured debt – this includes his credit card debt, car loan, medical bills etc.
If Paul wanted to pay off all his debt within 36 months without a consolidation loan, he would have to pay at least R13 251 in monthly instalments.
That means if Paul wanted to be debt-free within 36 months (3 years) and he would be paying R369 050 in total. That’s and additional R54 050.
But what if Paul decided on a consolidation loan? What would that look like?
The company Paul decided to consolidate with is giving him a loan at 27% and a monthly instalment of R10 798 to paid over 48 months (4 Years).
Paul would be debt-free in 48 months (4 years) but he’ll be paying R518 348 in total. That’s an extra R149 298 he’ll be paying.
Going for a consolidation loan doesn’t look quite right, does it? Why would you want to increase the amount you’re paying back?
There are better options if you’re looking for a way out of debt if you can’t afford a consolidation loan.
Paul can’t afford to tackle his debt on his own and a consolidation loan is not a good option for him. After some research online he realises that he might be over-indebted and that he should consider debt review.
Paul’s debt counsellor helped by creating a repayment plan that allowed him to make all his monthly repayments while being legally protected from creditors while being able to afford his living costs.
Paul’s approach was safer than a consolidation loan or payday loans.
But what exactly is Paul getting out of debt review?
The benefits of debt review
One of the reasons why consumers choose debt review is because the process provides legal protection. You also don’t make any more debt.
What makes debt review so appealing is that it allows you to have extra money to cover your living expenses.
So what exactly is debt review?
1) One single monthly instalment
Like a consolidation loan, debt review allows you to make a single monthly debt repayment.
Debt review is designed to keep your payments up to date at all times so that you become debt-free as quickly as possible. To achieve this, your debt counsellor will make reduced monthly debt repayments on your behalf.
2) Legally protecting your assets
When you’re not protected by a debt counsellor, your creditors have the opportunity to harass and threaten you with legal action. Debt review protects you from creditors trying to harass you or repossess your assets.
The legal protection from the court prevents creditors from doing so.
3) Lower monthly instalments
Once your debt counsellor renegotiates with your creditors, they’ll be able to reduce your monthly instalments. This will leave you with extra money for living costs, like food, child support etc.
4) Learn money management skills
The most important benefit of debt review is the skills you’ll gain.
Once you’re under debt review you will be provided with a personalised monthly budgeting and debt repayment plan. You will also receive expert advice on how to manage your money successfully.
How did debt review help Paul?
Paul can only afford R10 000 in monthly debt instalments, so Debt Rescue worked their magic.
Debt Rescue managed to renegotiate Paul’s debt accounts. Now Paul doesn’t have to pay that total R518 348. Instead, he’s paying a lower monthly instalment that he can afford.
Paul managed to extend his repayment period which helped reduce his monthly repayments. He’s is taking a little longer to pay off his debt, but now he has some extra money to pay for monthly expenses like school fees, groceries, transport etc.
Finally, Paul has some time to breathe and not stress about his debt. He can sleep knowing that he’s legally protected while making affordable debt repayments. Best of all, Paul only has to make a single monthly payment and his debt counsellor sorts out everything else on Paul’s behalf.
Now that is a good deal.
If you’re struggling to make ends meet like Paul, you may be over-indebted. The last thing you need is another loan, so stay away from consolidation loans and payday loans. Contact us today for a free no-obligation assessment and see if you need debt review.