Dealing with debt can be daunting. If you’re struggling to keep track of which store account to pay next and weighing up which credit card is more important to settle first, you may have considered debt consolation.
At Justmoney, we’ve decided to get down to the basics and explain what this entails and what impact you can anticipate on your credit score.
Tip: If you’d like a free debt assessment with a qualified financial adviser, simply fill in this form and you will be contacted.
Debt consolidation and its benefits
According to James Williams, head of marketing at short-term lender Wonga SA, debt consolidation involves taking out one large loan to pay off several smaller loans.
“Instead of paying off a number of separate loans each month – such as one’s credit card, store cards, and short-term loans – the borrower will only owe money to one credit provider,” says Williams.
He points out that consolidation loans should ideally have a lower interest rate when compared to the debts you would like to settle.
“Due to the lower interest rate and the fact that they can be taken out over up to a five-year period, meaning lower monthly payments, in some cases debt consolidation may be a good option,” says Williams.
“The monthly instalment associated with a consolidation loan should be less than the combined total of the smaller debt instalments,” he adds.
Who should consolidate their debt?
It’s important to protect your credit score so that you have access to financial products and services later in life.
Williams believes that if someone is struggling to keep up with their monthly debt repayments, it might be beneficial for them to consider taking out a consolidation loan.
“Late or missed loan repayments can have a negative impact on someone’s credit score, making it hard for them to access credit in the future,” says Williams.
“Keeping track of debt can be a lot simpler when only one payment is required at the end of each month. Therefore, the financial burden of one’s debt is easier to manage,” he explains.
The downside of debt consolidation is that the repayment term is stretched out in order to reduce the monthly payments.
Williams says that this can actually end up costing more in the long term. He therefore suggests that debtors should try to pay off these loans as quickly as possible.
Have a look at the following article to find out whether debt consolidation is right for you.
Impact on your credit score?
Consolidating your debt can in fact have a positive impact on your credit score, and the simple act of taking out a consolidation loan will not affect it negatively
“By making these monthly payments both easier and more affordable, a consolidation loan can help borrowers maintain a good credit profile and improve their credit score in the long term,” says Williams.
However, he adds that for someone who isn’t in control of their spending, this type of loan can have the opposite effect.
“Once one’s credit cards, store cards, and short-term loans are paid off, they will still have access to these facilities and can wrack up even more debt, on top of their consolidation loan,” says Williams.
He fears that this added financial burden can make it difficult for applicants to make monthly debt repayments, causing them to become overindebted and impairing their credit rating.
“Therefore, this option should only be used by people who are committed to taking control of their money and paying off their debts rather than people who just want to free up more spending money each month,” says Williams.
If you’re ready to take charge of your financial situation, fill in this form for a free consultation with a debt specialist who can take you through a no-strings-attached debt assessment.