Pros and cons of debt consolidation

2015-05-22 14:08
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Cape Town - Over-indebted consumers have various options to choose from to help them on their road to financial freedom, one of which is debt consolidation.

In a nutshell, debt consolidation involves taking out one single loan to settle all your other loans. This is often done to secure a lower interest rate or for the convenience of paying only one loan.  

Although debt consolidation has its advantages, there are also unforeseen negative consequences that need to be considered, says Clark Gardner, CEO of Summit Financial Wellbeing.

"Our opinion is that the negative consequences outweigh the benefits."

Advantages

• Making a single payment.

• The consolidated instalment may be less than the combined original instalments.

Disadvantages

• High fees. Many consolidation companies charge very high upfront fees and interest rates that are close to the maximum allowable rate for mortgage loans. This means that most of your monthly instalment is used to pay interest, and it is difficult to actually pay off your debt.

It can also put you under pressure if interest rates rise unexpectedly.

• A lower interest rate does not necessarily mean a saving. Debt consolidation loans are usually stretched over a long period, which means that your total interest payments add up to a very expensive debt.

Paying off short term debts like credit cards and personal loans over much longer periods, even at a slightly lower rate, actually means paying a lot more interest in the long run.

Although the lower monthly instalment may give you short term breathing space, it will keep you paying interest for up to twenty years.

• It can lead to more debt. Debt consolidation can cause the illusion that debt is being paid off. Unfortunately, many consumers see the “zero” balance on their credit card as a green light to go spend more. This will only make things worse.

• It does not reduce your debt. Debt consolidation merely replaces current debt with different debt, and is therefore not a solution for over-indebted consumers. In order to get on the road to financial well-being, consumers need to spend less, save for emergencies and pay off their debt with their own money.
 
Consumers who are unable to pay their basic expenses and debt should rather try to make payment arrangements with their credit providers or find out more about debt counselling.

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