Debt Consolidation: Advantage or Disadvantage? :: Mmegi online
It would be wonderful if there was a quick fix, a cheap and easy way that we could buy that in the blink of an eye would solve the problem. Is debt consolidation that solution?
Most of us also know that getting into serious debt doesn’t happen overnight. We got deeper and deeper into trouble over an extended period of time. Knowing this, we cannot expect “the solution” to be quick.
If someone talks to you (or tries to sell you) about a “quick and easy” solution, be suspicious. You must ask questions and read the T & Cs carefully. Beware of very expensive formulas, if you cannot afford it in the long run, this is not a solution at all.
What is debt consolidation?
We hear the term “debt consolidation” more and more and some of us have been told that this is the solution to all of our problems. Is this a smart solution or just another way to get even more debt?
Debt consolidation is a process by which you find a lender who agrees to take over all of your debts. Your new lender agrees to buy back all of your debts, so they pay off all of your debts on your behalf, and you owe them the money instead.
This way, you only have to worry about one debt, and therefore one debt payment per month. Sounds pretty good, and many of us see it as a solution.
However, you need to be careful – it’s up to you to find a lender who will charge you reasonable fees and interest rates for this service.
Why would you want to owe all of your debts to one lender? The reason for considering this consolidation should be in an effort to pay them off – either over a longer period of time, or with a lower interest rate (or perhaps both).
For example, if you’ve paid off half your mortgage, your property is worth more than you still owe. Because you are paying your mortgage over a long period of time, monthly principal payments are lower (but try not to go for a mortgage that is more than 20 years old). Also, since your mortgage lender has the right to take your house if you don’t pay it back, they consider the loan to be low risk and therefore the interest rate lower.
Therefore, if you can extend your mortgage to include a larger loan (called a re-mortgage), you could use that money to pay off more expensive debt. This could be taken as an example of good debt consolidation.
Reasons why debt consolidation is a downside
The problem with debt consolidation is that no lender will give you money for free, they will charge you for this service. It can get expensive and put you in even more debt. When you are already in debt, you should avoid taking on more debt.
The wrong side
If you are in arrears with your mortgage or are on the ITC or CRB blacklist, your mortgage lender will not be able to help you. This is where short term lenders can offer their help.
Taking out a short-term loan to pay off arrears or pay off debts to pay off with a credit bureau may be your only option. This is called a bridging loan. However, again, you have to be careful. Be aware that when you are listed as a bad debtor, higher fees will be associated with the loan granted to you. We have encountered up-front charges of between 15-25% and ongoing interest rates of 2-5% per month.
Even if you pay off your debt to this new lender within a month, you still have to pay a percentage of the debts for their help. If you get a bad deal it can be very expensive.
In short, you want to borrow as little as possible, and repay your bridging loan as quickly as possible. You should also shop around and get the best deal!
Remember, the ONLY good debt is one that buys an asset that grows in value and produces a secure income. Your home qualifies because it appreciates in the long term and you pay the rent for it – to pay off the mortgage.
With good debt, you can pay it off slowly – over a maximum of 20 years.
All other debts are bad debts. What you owe clothing stores, furniture stores, micro-lenders, cash loans, friends and family are all bad debt. The money you owe on your car is bad debt – your car loses in value by at least 10% each year.
Even if you have a loan to buy land, if that land isn’t earning you income, it’s not an asset, and therefore debt is bad for you because it costs you money.
For bad debts, pay them off as fast as you can. Pay the most expensive debt (highest interest) first, or pay off the debt that causes you the most stress first (like the one you owe your poor mother)
Weigh Debt Consolidation
The downside is the cost and slower debt repayment. You need to weigh these costs against the benefits:
One monthly deduction / payment
One administration fee – whether you come from your salary or through a union
A lower interest rate
A longer period to pay off the debt
A more affordable monthly payment.
Advice and guidance
It is best to consult a debt professional and get advice on a debt payment structure. A good debt counselor will know your situation and then help you develop a plan. You then work on your plan under the guidance of the advisor.
If an advisor thinks debt consolidation is right for you, they’ll talk to you. However, the advisor may advise you to avoid debt consolidation if it puts you in even more debt.
Getting out of debt is the goal
Remember, the only people who are happy with their finances are those who don’t have bad debts. Therefore, the goal is to get rid of all your bad debt.
You can do it. It will take time and effort, but you can do it.
You too can be debt free and happy.
* Neo Tshekedi is Director of Sales at Kalahari Training Institute (Pty) Ltd, known as KTI. The Kalahari Training Institute is the premier vocational training provider in Botswana, working with employers to improve the skills of all Batswana in the workplace for personal growth and productivity. KTI offers over 50 BQA accredited courses in all areas of business and industry. For help and information contact KTI on +267 311 4858 or 7430 0747 or email [email protected]
* Names in this article have been changed