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| DEBIT CONSOLIDATION: GUIDE |
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What is debt consolidation?
As the name suggests, debt consolidation is where you consolidate – or combine – a number of individual debts into a single debt. It is a relatively new concept in South Africa, although it has grown rapidly in popularity throughout the UK, Europe and the US in recent years.
Instead of having lots of little debts; such as store cards, credit cards, short-term loans and overdrafts, debt consolidation wraps all of those smaller debts into one bigger loan. At the moment in South Africa this usually means increasing your home loan and using the extra cash to pay off all your other small loans.
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Why consolidate your debts?
Having lots of smaller debts can be expensive and it can also be complicated to keep on top of all the repayments. Typically store cards and credit cards have interest rates ranging from 17% to 30%, whereas a short-term loan could have an interest rate of almost 40% depending on your credit history. So this form of borrowing is more expensive than a home loan, which will usually have an interest rate of around 12%.
On top of that you also have to remember to make your monthly repayments on each individual loan or credit card, which will probably mean lots of different payment dates, making it harder to keep track of what has to be paid and when. If you are late with a repayment, or you miss a repayment completely, you will probably be charged a penalty fee that will just add to the amount of money you owe.
So by having lots of little debts you will probably end up with lots of smaller, but expensive monthly repayments. If you consolidate all your debts into your home loan, on the other hand, you will have just one monthly repayment to make that will usually be less than all of your old monthly repayments combined.
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The impact of NCA
The introduction of the National Credit Act (NCA) has also made a big difference to the way people get credit and how much credit they are allowed to have. Now credit providers have to do more work to show that by giving somebody credit, whether it is a credit card or a loan, they are not making them over indebted. Being over indebted means there is a danger that the consumer may not be able to meet their loan obligations and may not be able to make their monthly repayments.
It also means that consumers have to prove they can afford any new credit agreement by declaring how many loans or debts they currently have, supported by evidence, as well as how much disposable income they have left after paying off their debts and other expenses.
Previously all a consumer had to do was show a provider a current pay slip to prove they earned enough to pay for the individual credit agreement they were applying for. This did not take into account the total amount of debts a person had, which sometimes could add up to more in repayments than they actually earned. This caused a lot of problems and so the NCA was introduced.
What this means is that consumers struggling with smaller debts are now finding it harder to take another small loan to fill the gap because they fail the new NCA criteria and are deemed to have too much debt already. They are literally drowning in debt and are in danger of missing payments and becoming bankrupt, which could even result in them losing their homes.
If they have a property, however, debt consolidation could get them out of difficulties, clear their debts and give them time to get their finances straight.
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How does it work?
Debt consolidation works because you combine all your debts into your home loan to provide a single more affordable debt. This is because a home loan usually has a lower interest rate and is spread out over a longer period of time, typically 20 years.
Here’s an example of how small debts add up:
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A credit card balance of R20,000 at a rate of 18% will cost you R300 a month in interest alone
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R30,000 on a store card at a rate of 25% will rack up R625 a month in interest
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A R50,000 short-term loan at 30% will generate interest of R1,250 each month
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So R100,000 in small debts will cost R2,175 each month just in interest repayments
And that’s without even paying off the actual amount you’ve borrowed – but if you only ever pay off the interest, your debts will never decrease.
If you also have a home loan of R500,000 at an interest rate of 12% over 20 years, you will need to find an additional R5,500 each month in mortgage payments.
Unconsolidated debts
So for a total debt burden of R600,000 you will have fork out R7,675 every month just to keep your head above water.
If, however, you were to also pay off some of the actual debt each month, say R500 for each of the small debts, for example, your total repayments on a R600,000 debt would be closer to R9,175 each month.
Consolidated debts
If, instead, you were to combine all your small debts with you home loan and take out a new mortgage for R600,000 at 12% over 20 years, your monthly repayment would fall to around R6,600 – saving you hundreds, possibly even thousands of Rands each month.
In addition you would now only have to make one single monthly repayment and you would be repaying off all your debts, not just the interest. To see exactly how this works, check out the debt consolidation calculator at Justmoney.co.za
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Equity in your property
To be able to consolidate your debts into your home loan you need have equity in your property. This means that the current market value of your property must be higher than the size of the home loan you have on it. If your property is worth R750,000 and you have a mortgage of R500,000, then your equity is the difference between these two figures – R250,000.
So if you currently have a home loan of R500,000 and you wish to consolidate R100,000 worth of smaller debts into a new mortgage, then your property needs to be worth more than the new home loan amount of R600,000. How much more will depend on the provider and what percentage the total home loan is of the value of the property.
The smaller the percentage of the value of the property – and therefore the greater the amount of equity – then the more likely the lender is to give you a debt consolidation loan. If you have a lot of equity then your lender might even be willing to lend you money in addition to the debts you are paying off.
If you have very little equity in your property then you might struggle to get a debt consolidation loan. Lenders will also need to take into account other factors, such as your income and your credit history. As with any credit agreement you will have to prove that you can afford to meet the repayments on your new debt consolidation loan. If you have a poor credit history because of missed payments or judgements against you, this may also count against you.
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A fresh start
Debt consolidation can help people make a fresh start. By rolling all their debts into a single, affordable loan, they can remove the stress of managing several loans and debts, can save themselves money on their monthly repayments, and take time to get their finances straight.
To make certain that people use their newly consolidated home loan to pay off all their outstanding smaller debts, many lenders actually insist on the consumer giving power of attorney to a lawyer whose job it will be to pay off those debts on the consumer’s behalf. They will probably even close down your credit card, store card and short-term loan accounts as well. This ensures that the original debts are cleared and that you are not able to incur new debts by keeping the cards and loans open.
As a result of the NCA, it also means that once you have taken out your consolidation loan, you will find it harder to get new credit anywhere else – such as store cards or credit agreements – because you might not meet the NCA’s criteria.
It is also important to take responsibility for your own debts and ensure that you do not start spending more than you earn and begin building up debts again. You should also be aware that because your new debt consolidation loan is a home loan, and therefore secured against your property, if you do not keep up repayments you will be at risk of losing your home.
If, as a result of your consolidation loan and new lower monthly repayment you find you have money left over at the end of the month, you should pay more into your home loan because not only will this bring down the length of your mortgage, it could also save you tens or even hundreds of thousands of Rands in mortgage repayments.
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Fees and charges
Increasing your home loan to consolidate all your other debts will incur additional fees and charges. You will need to check with your lender or broker to establish how much these will be.
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When is debt consolidation not suitable?
Debt consolidation is most suitable for people with a significant amount of debt. If you are looking for a loan of R20,000, for example, you would be better off getting a short-term loan and paying it off over three or four years.
If you are purchasing something like a piece of furniture or electrical item, rather than taking out a loan from the retailer, it might be more cost-effective to purchase it on a credit card with a lower interest rate of 17%, and then pay it off over a few months or a year.
But as always, before considering any credit agreement or loan, it is vital to make sure you can meet your monthly repayments and will be able to pay off you debts. Failing to do so could leave you in big trouble.
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Justmoney.co.za
If you are struggling to pay your debts, or you are worried that you have too many smaller debts, it is important to investigate debt consolidation sooner rather than later and before your total debt burden gets too much for you.
Justmoney.co.za has a debt consolidation calculator to help you work out what the best solution is, how much you can afford and how much you could potentially save. Check out our debt consolidation category and speak to a consultant from our partner BondBusters to get more information about consolidating your debts.
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