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What is debt consolidation?

And how does it work?

Cape Town – For many South Africans the burden of debt is all too real. Large numbers of South Africans are spending significant chunks of their incomes servicing loans.

Last year’s FinScope South Africa survey showed that around five million South Africans are battling with over-indebtedness. That equates to 14% of the population over the age of 16.

Some of this will be long term debt in the form of home loans, but the real problem is short term, high interest debt in the form of personal loans, store credit and credit cards. The compounding effect of the interest on this debt is what is eating into disposable incomes all over the country.

For anyone who finds themselves in a situation where their debt is overwhelming them, a first step toward trying to address this may be debt consolidation. Most of South Africa’s major banks and financial services companies offer these solutions.

“Debt consolidation is a good idea if you are battling to keep track of your debt due to it being spread across a range of accounts and loans, if you are unable to meet the monthly required minimum repayments or if you simply want to find a better rate,” explains Johan Maree, the CEO of FNB Credit. “It is an effective way of taking control of debt as it allows you to merge retail store debt, short term loans, personal loans and other credit card debt into one account,”

The principle idea behind debt consolidation is that it allows an individual to pay off all their existing debts and be left with only one remaining creditor.

“The customer provides FNB with a list of the various debts that need to be settled and based on that, provided the customer qualifies, the bank will credit the customer’s account with the required amount so that they can settle their outstanding debt with their various creditors,” Maree explains. “This results in one amount being owed to the bank as opposed to a number of different creditors that have to be paid, often at high interest rates.”

Some other institutions, such as Old Mutual, approach the paying off of loans slightly differently.

“The customer provides us with settlement letters from the existing creditors,” says Werner Alberts, CEO of Old Mutual Finance. “We then settle the debt directly. We never pay the settlement amounts to the customer as it opens the temptation not to settle with creditors and instead the customer just doubles up their debt.”

There are a number of benefits of following the debt consolidation route, most particularly in terms of saving on interest and other costs. A single repayment to a bank may be lower than having to pay a range of institutions separately, and it might also result in significant savings in monthly administration fees and bank charges.

“The customer also only deals with one credit provider rather than having to deal with multiple credit providers,” says Alberts. “Because Old Mutual Finance settles all the existing debt directly, there are also no hassles for the customer to pay off the existing creditors.”

Many products also allow customers some flexibility in terms of accessing additional funds should they need them.

“Old Mutual’s My Money Plan consolidation product includes annual pay-outs when the customer needs money, such as in January each year when funds are needed for school fees and school clothing,” Alberts explains. “Customers could also elect to receive a regular monthly amount that is paid out a week before pay day to assist with the last week’s living expenses before pay is received.”

All debt consolidation solutions are however only available to people who meet the normal credit criteria set out by the institution that offers the product. So if you wouldn’t qualify for a loan at a bank under normal circumstances, you won’t be able to access debt consolidation either.

“Some of these requirements are that the customer must be in full-time employment and cannot be under debt review or debt administration,” says Alberts. “We also only settle existing debt that is not more than two months in arrears.”

Importantly, service providers also require those who consolidate their debt to act responsibly.

“We ask our customers to give us a commitment that they would not incur new debt once they have taken our consolidation loan and to talk to us if they experience any difficulties,” Alberts says. “The consolidation loan size is restricted based on the customer’s affordability, income and risk profile. We will never grant a loan of more than R150 000 and the repayment term is restricted to 60 months.”

Anyone thinking of debt consolidation should therefore not just see it as a means to free up more spending money, but as a serious step towards ridding themselves of debt.

“We always stress that debt consolidation is not a “get out of jail free” card, but merely a way in which to make the management of debt easier by lowering monthly repayments,” Maree says. “Debt consolidation will not help consumers who spend above their means to curb their spending. In order to make long term behavioural changes to spending, debt has to be actively paid off and a deliberate effort to foster better spending habits and reducing expenses has to be made.”

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