Should you consolidate?

Sounds great doesn’t it? Instead of writing out 10 cheques to 10 different creditors you can make one easy payment to a single source and the bill-writing headaches should be gone forever. Better still, by consolidating your debt you could get the added advantage of reducing your monthly payments. So what’s the catch?

Should you consolidate? 

Iona Minton

This article is a printout from iafrica.com
Copyright © 2000 iafrica.com*, a division of Metropolis*

I like the word ‘consolidation’. It conjures up images of control and order. You can consolidate virtually anything; travel plans, a wardrobe, a job, and even thoughts. Lately, consolidation of debt has become a hot topic and many individuals are trying to take advantage of the benefits it is supposed to deliver.

Sounds great doesn’t it? Instead of writing out 10 cheques to 10 different creditors you can make one easy payment to a single source and the bill-writing headaches should be gone forever. Better still, by consolidating your debt you could get the added advantage of reducing your monthly payments. So what’s the catch?

Well, the first thing you need to know is that financial institutions don’t offer the service because they love you; they clearly make money from the exercise. The business of lending money is very profitable and the more money they can lend a client, the more interest they earn.

Banks have a lot of competition out there and retailers have cottoned on to the fact that they too can make money out of extending credit to their clients. Over time the banks have had a decreasing share of the credit pie. If they have a client who has a good credit record and is keeping up with their payments, why not give them cash to pay off other loans and start earning the extra interest?

However, although the reduced payments and extra cash may look very appealing, let’s have a look at a few curve balls you may have to deal with:

Do you qualify?
A consolidation loan is not always easy to get. Some of the loans are pre-approved, but if you have heard via the grapevine that they are available, be aware that you have to be a good credit risk to qualify.

A car repossession or judgement against your name will probably knock you out of the running. The rules vary depending on the institution you approach and some of the specialist banks require you to be earning over R400 000 a year in order to qualify for a debt consolidation programme. Call around and see who is offering the best deal for your particular requirements. Don’t be afraid to negotiate either; if you have a good record they will be keen to have you as a customer.

Fees & penalties
There may be costs involved. Sometimes terminating a credit agreement attracts cancellation fees and penalty interest. Do the sums first to see if consolidation is worth your while. Your financial advisor should be able to help you with this.

Lower payments, longer term?
Sometimes the lower payments are achieved by extending the finance period. This may give you temporary breathing space, but you will pay a lot more in the long run. The longer the borrowing period for the more expensive it becomes.

If your credit card company offers to pay off other debts at a much-reduced rate, check the fine print. Often the reduced rates only last a few months. While you are on the lower rate you may well see savings, but if you replaced a loan that was at a slightly lower rate than the rate that kicks in later, you could end up paying more for some short-term relief.

Consolidate, then close
Let’s say a bank gives you the money to settle all your accounts and you diligently write out those final payment cheques. Then you say to yourself: “I won’t close them all, just in case there is an emergency”.

If one emergency after another happens (you know, like just having to buy a new outfit for that important business meeting!), you could end up with all your old debt plus the consolidated debt. If you consolidate, close those accounts and make sure that the creditor states that the account was closed on your request — you don’t want it to look like the creditor closed your account.

Who should consolidate?
Many people turn their thoughts to consolidation when the wheels are about to fall off their financial planning (or rather, lack of planning). As previously mentioned, your chances of getting a consolidation loan are greatly reduced if you are falling behind on payments, so you need to get things back on track first.

Try to pay off some of your smaller accounts first, so that when you approach the bank they can see that your instalments are affordable.

Consolidation can be very effective if you have a number of high interest rate loans. One of the best ways to reduce your interest payments is to take out a home equity loan, although most new bonds nowadays are ‘access bonds’ — this means that if you have built up equity in your home you may borrow against that value.

If you have a car loan and a few credit cards it will be cheaper in terms of interest charges to take money from your bond to settle this debt; as long as you direct all that extra cash into settling the bond. A home equity loan has the advantage of carrying a fairly low interest rate when compared to the rates charges on credit cards and motor vehicles.

The key to success when using this type of financing facility is to make sure that you make extra repayments each month to ensure that you do not extend the time it takes to pay off your bond.

The bottom line is that consolidation, used wisely, can save you money if you stay disciplined and focus on settling the debt early. Just make sure you read the fine print, maximise the opportunity to get out of debt and (as with all things financial) only deal with reputable institutions.

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