How does a debt consolidation loan work?
What is debt consolidation?
Are you struggling with multiple credits that all require monthly repayments at the same time? If so, debt consolidation may be the solution that allows you to breathe a little easier. This financial product combines all your smaller debts into one load of debt.
With all your debt in one account, you can easily manage all your repayments. Furthermore, you can save money on interest, especially if you pay the debt off quickly.
How to consolidate your debt
- Calculate how much money you owe on all your loans.
- Work out the total you can afford to pay back your monthly debt amount.
- Find a lender that best suits your budget.
- Apply for a credit with your chosen lender.
- Use the funds received to pay off all your old, existing loans.
- Start paying off the new debt as per the agreement with your lender.
Consolidating secured vs. unsecured loans
What type of debt can you consolidate? Debt consolidation applies to both secured and unsecured loans.
Secured loans are taken using valuable property or assets as collateral. For example, individuals may use their homes or cars as security that they will repay the borrowed amount. If you default on the agreement, the lender is entitled to claim the home or car. Types of secured loans include:
Unsecured loans don’t require collateral. As a result, they carry a higher risk for the lender and higher interest rates for the borrower. Typical examples are:
Different methods of debt consolidation
In South Africa, you have many options to choose from if you want to consolidate your debts into a single one. Most lenders will look at the size of your debt, income, and your credit score to determine eligibility.
Debt consolidation loan
Debt consolidation is specially designed to help you pay off a considerable amount of debt. This can be done over many years and at a lower interest rate. Taking out a debt consolidation loan doesn’t require security or collateral.
South African registered credit providers offer as much as R250 000 for this type of credit with interest rates (APR) ranging from as low as 15%. You will also be charged a small admin fee for handling the paperwork.
Secured personal loan
A secured personal loan is an easy way to get a high amount of credit, even when your credit score is not good. Lenders who offer authorized financial services will readily advance you this type of loan if you have a valuable asset such as a car to use as collateral.
Balance transfer credit cards
Typically, new credit cards have promotional interest rates that are set at 0%. You can transfer your existing debt to this new card to avoid paying more on interest. This can be done at no cost or by paying a small transfer fee.
Also, once the promotional interest rates expire, the standard rates may become too expensive. Thus, balance transfer credit cards are only useful if the debt is paid off quickly.
Home equity loans
These allow homeowners with equity in their homes to borrow using the home as collateral. The borrowed amount is then used to consolidate any debt. This is a form of secured loan. While it offers lower interest rates, you risk losing your home if you default on the home equity loan.
What is the difference between debt consolidation and a personal loan?
There is no real difference between a personal loan and a debt consolidation loan. Once you use a personal loan to consolidate debt, it automatically becomes debt consolidation. In simple terms, you can use a personal loan for anything, including debt consolidation.
However, some lenders do offer specialized debt consolidation loans for individuals with a high debt load. In such cases, the lender will typically pay off your credits directly.
Pros of debt consolidation
Debt consolidation offers the following advantages:
- debt repayments become more manageable;
- your instalments could decrease, offering you much needed breathing space; and
- it helps you manage your debt effectively and may steer you away from a high-risk customer profile.
Cons of consolidation loans
Debt consolidation is not a one-stop solution to all your financial problems:
- it won’t help if your debt load is out of control;
- you can end up paying even higher interest rates; and
- it doesn’t make your debt disappear or fix bad spending habits.
What to consider when consolidating debt with a personal loan
Debt consolidation using a personal loan can save you money on interest and help you manage your monthly bill payments. Yet, a debt consolidation plan has to be smart in order to work. Consider the following things before going ahead with your plan:
- Can you afford the new monthly plan? – Only take out a personal loan to consolidate your debt if you are sure you can afford the new monthly installment.
- Is the size of your debt something you can handle? – Be honest with yourself. Is your debt overwhelming or under control? If it’s too much then debt consolidation may not be the solution.
- Can you reduce the size of that debt? – The only way to do this, is by paying off the debt while reducing expenditures.
- Is your credit score favorable? – Continuing paying your debt off as it is, might be better in some cases. This is because a bad credit score means you will have higher interest rates on the personal loans available to you.
What you need to apply for a consolidation loan
Applying for a debt consolidation loan in South Africa is easy and only requires the following:
- proof of income showing salary deposits for the last three months;
- bank statement showing salary deposits for the last three months;
- proof of residence less than three months old; and
- you should also be 18 years and older.
Learn more about debt consolidation in this short video
Frequently asked questions about debt consolidation
When is the best time to consolidate my debt?
When your monthly bill payments are many and more than you can afford.
How does debt consolidation help me get rid of my debt?
With all your debt under one account, it becomes easier to lessen your debt load. The faster you pay off your debt, the more quickly you can live a debt-free life.
Will the lender settle my debts for me, or do I have to do it myself?
When your lender specializes in debt consolidation, they can handle the debt settlement on your behalf. If you take out a personal loan, it is your responsibility to ensure your debt is consolidated.
Do I qualify for a debt consolidation?
It all depends on your credit score, monthly income, and other factors. The best way is to compare different lenders and figure out which one has better eligibility terms.
Can I consolidate debt that is in someone else’s name?
No. All debt that you wish to consolidate has to be under your name.
Will a debt consolidation loan improve my credit score?
In the short term, the answer is yes since you will have paid off your old accounts. Long term credit score will only improve if you don’t default on repaying the new credit. If you have a poor credit rating, learn more on how to improve your credit score.
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