You can lower your total monthly bills by consolidating your smaller loans into one larger loan. This will help your cash flow so you have a little relief from the financial pressures you’ve been facing each month. Furthermore, you will end up paying a lower rate of interest overall on your debt. Unsecured debt consolidation loans are used to replace smaller short-term debt with high interest rates with a longer-term loan at a lower rate. If you are carrying high-interest credit card debt, you can pay a lot less interest by consolidating your debt.
If you own property and have built up some equity (the value is more than you owe) you can easily apply to borrow more against your current bond. When you consolidate your debt in this manner you get relief from the high interest you are paying on your smaller loans. This allows you to get a fresh start and have a lower installment payment every month, something more manageable. Additionally, you will save money because you won’t have to pay those debt order charges, service charges and fees associated with all those other loans.
When you obtain a debt consolidation loan, your monthly cash flow will improve because you won’t be making payments on all those other small loans each month. If you are pushed to the wall every month with bills, a secured or unsecured debt consolidation loan might be the answer. This would save you from the threat of foreclosure or car repossession.
Being honest, for you to fully benefit from an unsecured debt consolidation loan, you will have to curb your spending. If you don’t, you risk getting into more serious financial trouble.
The following chart illustrates an example of how this type of loan could help. This chart shows the details for someone with the following financial obligations:
Financial Details Home Mortgage Car Loan Personal Loan Credit Cards
Amount owed: R600 000 R120 000 R45 000 R25 000
Repayment Period: 20 years 5 years 4 years Ongoing
Rate of Interest: 9% 16% 18% 20%
Monthly repayment: R5 398 R2 920 R1 320 R1 000
For this person to consolidate their debt they would add R190 000 to their Home Mortgage. They would use this money to fully repay all their smaller loans listed above. Once they do this their home loan would increase to R790 000 and their monthly mortgage payment would be R7 110 pm, but this would not include insurance, other charges and fees.
In this particular scenario, they are saving about R3 528 pm each month, which does help their cash flow. They would save about R1 250 (or R15 200 pa) each month just in interest.
(The exmple above is just to show how debt consolidation loans work. How much the actual person would benefit would depend on their particular financial circumstances and what rate of interest they qualify for.)
This honestly looks like an ideal solution since it improves the person’s monthly cash flow and they are paying off their debts at a lower interest rate.
What’s the downside?
Looking closer you’ll notice that they are definitely saving money every month on interest, but the reality is that the reason their payments are a total of R3 500 less every month is because they’ve extended it out for up to 20 years. This is the notional time period attached to their bond. Otherwise these smaller bills would have been paid off in 3-5 years total.
If you examine the bigger picture, they are paying quite a bit more in interest in the long run on all those smaller debts. Many people find they are still essentially paying on their car long after it’s been sold.
Can this situation be avoided?
Yes, there are ways to prevent this from happening, but it takes discipline. If you were the person in this example you would start off using as much of the additional cash flow money each month of R3 500 to pay towards your bond. If you were really able to “tighten your belt” and put the entire R3 500 towards your bond your house would be paid off in full in under 10 years, instead of 20, which is where it stands now. This would save you R540 000 in interest alone.
Generally speaking, it may not be the best advice to pay your short-term debts off by getting long-term financing. But, in certain situations it may be the only sensible option. If you were in a situation where you were going to have to default on your loans and you need more monthly cash flow to avoid that risk, a debt consolidation loan could be your best option.
This could give you the lifeline you need right now and it definitely beats having a judgment against you, a home foreclosure or vehicle repossession. But, there is no doubt that it would benefit you enormously to pay off your short-term debt as quickly as possible.
The risk you’re taking is that if you cannot curb your spending you could be in real trouble again. And if this happens, you won’t have the same options. The only way you will benefit from consolidating your debt is if you can avoid going into further debt. You will need to stop overspending and live within your means.
It is always advised that unsecured debt consolidation loans are best used for saving money on interest. These types of loans are not supposed to be used to lower monthly payments on other long-term debt you may be carrying.
In sumary, it is up to the borrower to be responsible when taking out an unsecured debt consolidation loan. By this I mean, they must stop overspending in order to reap the benefits. If unsecured debt consolidation loans are used wisely, they can provide a financial lifeline.