According to DebtBusters debt consolidation is another debt management option to consider when you owe a large amount of money to creditors. It involves using new debt to pay off existing debt that’s owed to creditors.
"When done correctly, debt consolidation can help you get out of debt faster by paying less interest on debts and correctly managing your finances,"says DebtBusters.
"Debt consolidation is a mechanism which combines several loans or credit from different providers into one loan," says Gary Green, managing director of Ké Concepts, a credit management and lending solutions company.
How does it work?
Green pointed out that debt consolidation is similar to applying for a loan, but the credit provider is paying off debt owed to other credit providers on the behalf of the applicant and creates a single loan. Click To Tweet.
It is important to note that when applying for debt consolidation, you are still required to meet the necessary credit risk criteria. This will ensure that you are able to afford to repay this loan (the debt consolidation).
If you do not meet the necessary criteria (scroll down to view the criteria), then you will not be grant the loan for debt consolidation.
“The intention is to have one loan at a lower interest rate than the individual loans thus lowering the cost of credit. This would only apply if the applicant does not increase the repayment term of the new loan,” adds Green. Click To Tweet.
According to Green, when considering applying for debt consolidation, you should approach one of the major banks, or a larger micro-lender, as they are more likely to provide this facility.
The benefits of debt consolidation
One of the benefits of making use of debt consolidation is that instead of paying different creditors, all your debt is bundled under one umbrella, and you make one payment. Click To Tweet.
Green pointed out that when it is used responsibly, debt consolidation can reduce the cost of borrowing by having a single larger facility at a lower interest rate than the combined loans.
Furthermore, debt consolidation can also reduce the credit burden for someone who does not have enough available cash to pay for necessities after paying instalments on all their individual loans. Click To Tweet.
It can assist the applicant to budget better because a single repayment is easier to manage than several individual repayments. It should reduce bank charges because only a single payment needs to be processed.”
Choosing debt consolidation
One of the reasons that people opt for debt consolidation is that it’s a means to reduce over-indebtedness by freeing up some available cash flow for essential items.
The monthly instalment required to service the debt can be brought down if the cost of borrowing is reduced and the new loan has a longer repayment period, says Green.
“It can be used as a mechanism to avoid going under debt counselling because of an inability to repay your debt. Debt counselling would incur additional charges payable to the debt counsellors and prevent the debtor from applying for any additional credit whilst under debt review,” he adds.
However, there are risks associated with debt consolidation. One of these risks is that you could qualify for more loans, which may lead to over-indebtedness.
If you do qualify for more loans, the temptation will always be there to borrow more. If you know that you would fall into that trap then debt consolidation may not be fore you.
You may now qualify for more loans as their net cash position has been improved through the consolidated loan, and could end up being over-indebted.
Converting short term debt into longer term debt through a consolidated loan may ease the monthly repayment burden, but this will also increase the amount of interest repayable over the longer term. It requires strict self-discipline on behalf of the individual to stick to the repayment of the single loan and not apply for any additional loans.
It can be difficult to get a loan for debt consolidation. However, DebtBusters says that if a credit provider does grant you a debt consolidation loan, they will usually loan you the money with high interest rates attached.
"High interest rates are not the answer to your situation, as it will make it more difficult for you to pay back your debt,"says DebtBusters.
Debt counselling is an alternative debt management solution which can assist you with settling your debt. You will be able to pay off your debt, within a period of five years and less, based on the amount of money you can afford to pay towards your debt each month.
The criteria for debt consolidation
DebtBusters provided several recommendations for people to consider when deciding if debt consolidation is the best course of action for them:
- The interest rate of your consolidated debt (the loan to pay off your debt in one payment) is lower than the debts you are consolidating (the various debts that you are paying off).
- Each month, the money needed to pay off your debts should be lower.
- Don’t trade fixed-rate debt for variable-rate debt. The risk associated with a variable rate is that the rate could start out low, but may move up.
- You should aim to pay off new debt as quickly as possible. Ideally, apply all the money you save by consolidating to paying off the new debt.
- Do not commit to any additional debt until your consolidated debt is paid off.
“It is very important to manage your money properly, to avoid landing up in further debt,” says DebtBusters.
If you do not qualify for debt consolidation, there are other methods available to help you manage and paying off your debt. These include debt counselling and debt management.
If you want to apply debt consolidation, click here.