Debt consolidation loans: What are they?
If you find yourself in multiple different types of debt, it can often be a stressful process to pay them all back on time to avoid incurring unnecessary late fees. This is why many South Africans are now turning to debt consolidation loans in order to make the repayment process simpler and more affordable. Essentially, debt consolidation is when a lender buys all of your different debts and you repay them a single monthly fee which is extended over a long period of time. This guide will take you through all of the details of debt consolidation loan, including its advantages and disadvantages, to help you manage your finances.
In This Guide:
- What is debt consolidation?
- Why would I get a debt consolidation loan?
- How does it work?
- Things to consider
- Will it affect my credit record?
- Advantages of a debt consolidation loan
- Disadvantages of a debt consolidation loan
What is debt consolidation?
Debt Consolidation can come in two forms, either debt review consolidation or a debt consolidation loan. Debt review consolidation is a process where a debt counsellor will examine your debt and speak to your creditors arranging lower interest rates and a term extension. A debt consolidation loan is the merging of all your debt into one single monthly payment.
Why would I get a debt consolidation loan?
If you find yourself paying many different smaller debts, the overall interest could be higher than if you were to just pay it off simply with one monthly payment, with a fixed interest rate. It is often used by people who want to pay off long-term debt effectively and in a simple way. However, it can also be more expensive depending on your specific circumstances, so it is important to compare loans before applying.
How does it work?
To see if you can take out debt consolidation loan credit providers will need to examine a few details first. These include, but are not limited to:
- Income after tax
- Financial obligations and expenses
- The amount of money left over after income and obligations
Once you are successful, your lender will either deal directly with your creditors and pay back your debts, or they will give you an agreed amount and you settle the debts yourself.
Things to consider
Before taking out a debt consolidation loan you need to make sure you are okay with paying off your debt over a longer term. You cannot incur more debt whilst you are paying off a debt consolidation loan. It is important to remember that in order for debt consolidation to work you need to be disciplined in your payments. Debt consolidation is offered in line with the National Credit Act (NCA) of 2005, so make sure when you apply for consolidation it is with a company which abides by this.
Will it affect my credit record?
A debt consolidation loan will not automatically affect your credit record, but you should avoid taking out additional loans at all costs. If you fail to keep up with the payments for debt consolidation, then this will affect your credit record. Additionally, a debt review process will affect your record as it will show up on your file, and therefore creditors may not be willing to lend to you.
Advantages of a debt consolidation loan
- One monthly payment will usually be a more favourable interest rate than several payments, all of which will have their own specific interest rate
- By taking these steps and settling your debts, you will normally improve your credit score
- Overall, a debt consolidation loan is found by many to be a much less stressful experience than paying off several debts at once.
- It will give you access to more money per month because of a lower monthly repayment of loans.
- In some cases, the lender will do all of the legwork, and pay off all of your existing debts, so you will only have to go through them from now on.
Disadvantages of a debt consolidation loan
- You will be servicing this debt for a much longer period because of the extended repayment time.
- Although you are paying a lower monthly bill, the higher interest rate involved with a debt consolidation loan means you will overall pay more.