Deep in debt? Here are your options!

Piet van der Walt, Head of Sanlam Personal Loans.

Short-term debt is stressing out many South Africans and the recessionary environment is making it increasingly difficult for them to meet debt repayments or pay off debt.

This is clear from the latest Sanlam Benchmark research, where more than 70% of the 1317 South Africans surveyed confirmed high levels of financial stress, with 54% attributing their stress to short-term debt and 27% acknowledging that they will find it difficult to meet debt repayments or pay off debt.

Piet van der Walt, Head of Sanlam Personal Loans says “If you consider that every single item bought on credit ends up costing you far more than the original price-tag, it (credit) is something that is best kept to an absolute minimum, particularly during a recession.”

To avoid sinking deeper into the debt spiral you should take firm action to get your debt under control. “You should work with a financial planner to manage your debt as part of a holistic financial plan to ensure you do not get into trouble. He or she will holistically assess your monetary situation and advise on the best road to financial recovery.”

If the levels of debt are very high, the financial planner may advise that you consider one of two strategies to help manage repayments and secure the best possible interest rates on debt. “Debt consolidation is the first option. Here an individual’s debts are consolidated under one larger debt – usually a personal loan or add-on to a home loan – that has a lower interest rate than multiple debts. The second option is debt review, where a debt counsellor or payment distribution agent negotiates with creditors on the consumer’s behalf to reduce interest rates and set an achievable payment plan.”

Which of the two approaches is best will depend on an individual’s set of circumstances. Here Van der Walt considers the pros and cons of debt consolidation and debt counselling.

Debt consolidation:

Debt consolidation means using one loan (ideally one that offers lower interest and longer terms such as a home loan or personal loan) to pay off multiple smaller loans (typically high interest, short-term debts), such as those accrued from store cards, vehicle repayments and credit cards. This loan can either be taken out with the express purpose of doing this or an existing loan can be extended to absorb the other debts.

Pros:

• Having only one monthly repayment has many advantages. It means an effective monthly budget can be set and there is less likelihood of missing a payment, so a positive credit profile can remain intact.
• The total monthly repayment should be lower. Short-term, unsecured debts generally have high interest rates, whereas once all debts are consolidated, the respective debts will have been paid off. The larger loan is paid off over a longer term which generally means a lower interest rate.
• The service charges, debit order charges and fees mounting up from numerous debts are avoided.
• You won’t be flagged as over indebted. Credit remains accessible. This could be a pro or a con depending on how responsibly it is used.

Cons:

• Financial discipline is required to make this option work. When taking out a new loan to consolidate debt, often the loan is paid directly into the recipient’s bank account rather than to the creditors’ accounts. This increases the temptation to spend. If the loan amount is not used to settle debts, you may face a new debt repayment and will still have to pay off the smaller existing debts.
• If you are not deeply committed to becoming debt-free you may be tempted to access new avenues of credit once you feel your debt is under control.
• If credit repayments have already been defaulted on, you are unlikely to receive a consolidation loan. In this case, debt review may be the only option.

Debt review (also known as debt counselling):

If you get into a position where you can’t pay off your creditors then you can apply for debt counselling with a respected debt counselling company. Your financials will be rigorously assessed and, if you meet criteria, you’ll be accepted into the programme and a debt counsellor will negotiate with creditors, get them to agree to a final repayment plan with fixed terms, and obtain a legal consent order form. The repayment plan is submitted to a payment distribution agent who takes a monthly lump sum from you and distributes it among creditors according to the fixed terms agreed.

Pros:

• The debt counsellor can negotiate lower rates and longer terms with creditors on your behalf.
• Your assets cannot be touched and legal action cannot be taken against you while you are receiving debt counselling.
• Once the creditors have signed the repayment agreement they can’t individually change any of its terms.
• Someone works with you to manage your debt, giving you a clear plan to follow and executing it on your behalf.
• You can no longer access credit – this can be a pro or a con depending on your situation. Once all debt is paid, you will be cleared to access credit again.

Cons:

• There are fees involved, namely: an application fee, rejection fee (should your application be unsuccessful), restructuring fee, small monthly fee, and legal fee for the consent order. There’s also a withdrawal fee if the person prematurely withdraws from the process.
• You will be listed as undergoing debt counselling on credit bureaus. During this listing, it is illegal for any organisation to loan you money. This measure is in place for the good of the individual and once all debts are paid they’ll be issued with a clearance certificate and all records will be removed.
• The process can be long – short-term debts can take five years or longer to clear – and the monthly fee to the debt counsellor can rack up.
• A regular salary is compulsory before this process will be entered into.

Van der Walt believes that if you can afford to consolidate, it should be the preferred option as it keeps your name clear and allows you to retain access to credit. However, if this option is not workable due to the extent of the debts, then debt review assists with creditor negotiations and achieving better interest rates.

“Before making a decision, it’s best to consult a financial planner who can help guide the person towards an optimal path of long-term financial wellbeing,” he concludes.