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The implications of debt consolidation
12 October 2015
When times are tough and budgets are stretched, people begin thinking about consolidating debt and stretching out the repayment time. The immediate concern is being able to survive financially by getting those monthly payments to shrink as quickly as possible.
But, although relief may be immediate and you are able to breathe again, there are things to think about before consolidating debt and committing yourself to a longer period of debt payments, warns Theunis Kruger, Head of Unsecured Lending at Standard Bank.
“It is a sad fact that millions of South Africans spend a large part their monthly income to service debt in the form of instalment sales and account-based spending. They have to settle these payments before even thinking about putting food on the table. It is a no-win situation that becomes unbearable when an unexpected expense comes along and destroys what little spending money is left over after monthly commitments are met.
“In many instances the solution is debt consolidation. But before the step is taken, the impact of consolidating different debts should be considered, says Mr Kruger.
Typically you can categorise debts into short and long term. Short-term debts include credit card debt, personal loans and store cards. A long-term debt would be a home loan, where repayments stretch over 20 or even 30 years.
It is when the two are placed into the same ‘payment pot’ when consolidating debt that things can become much more expensive than most people realise.
“The main objective becomes seeing monthly commitments being consolidated into a single manageable payment, but the implications of long repayment periods on personal cash flow is not fully considered,” says Mr Kruger.
“So, for instance, you could approach your bank to utilise the ‘credit’ you have in your home loan to consolidate your debt. This means that all your short-term loans such as credit cards, accounts, personal loans and car payments are paid off. You then have the remaining term of payments on your home loan to use to clear the payment on the single, large debt.”
What needs to be clearly understood however, although not to shy you away from consolidation in a time of need, says Mr Kruger, is the following:
- Consider a personal loan of R 20 000 payable over 48 months at 14.25% interest p.a. The following would apply:
- Monthly repayment: R549.04
- Total payment over 48 months: R26 353.97
- With the payment extended to 84 months at a reduced interest rate of 11.25% p.a. The following would apply:
- Monthly repayment: R345.08
- Total payment over 84 months: R28 987.00
- Additional payment over the longer period: R2 633.03
- Consider a larger ticket item, say a car on which there is R 150 000 still owing and a term of 48 months outstanding. As this is a major expense and it is being combined with other debt, a repayment period of 10 years is put in place, with the additional payment going on to a home loan. If the same interest rates are applied the following would occur:
- Monthly payment over 48 months (14.25%): R4 117.81
- Total payment over 48 months: R197 654.76
- With the payment extended over 120 months (11.25%)
- Monthly repayment: R2 087.53
- Total payment over 120 months: R250 504.10
- Additional payment over the longer period: R52 849.35
“These calculations are made on the basis that no settlement discounts are offered when a loan is paid off and moved from a short-term situation into a long-term cycle. However, it is unlikely that these discounts will offset the additional costs that are payable. If short-term debts include retail accounts such as clothing accounts, it would be unusual to even be offered a settlement discount.”
What consumers should think about when considering spreading out their debt load is:
- Understanding the repayment implications of your consolidated long-term loan.
- Comparing interest rates across all debts that are owed.
- Only using long-term debt solutions when it becomes absolutely necessary.
- Consider paying extra into the account every month as soon as possible to reduce the loan period and save you money.
“And finally, remember to not take out any further debt until this loan is paid back, otherwise you may find yourself in the very same situation,” concludes Mr Kruger.