As the New Year dawns, many South Africans seize the opportunity to reset, often resolving to tackle pressing financial issues like debt.
Between debt consolidation and debt review, it is important that South Africans understand their debt options so they can make a decision that suits them.
Here is a closer look at debt review and debt consolidation.
Debt review
Debt review is a legal process has been created to help over-indebted consumers to achieve financial freedom, according to Lebo Gaoaketse, head of Marketing and Communication, WesBank.
This process of debt review involves the assessment of an applicant’s financial situation by a registered debt counsellor, negotiating on behalf of an applicant with creditors for reduced monthly payments, and restructuring the applicant’s debt into a more manageable repayment plan.
"The plan is then made a court order, mitigating legal action by creditors against the person undergoing debt review," Gaoaketse said.
Advantages of debt review
- Reduced monthly payments: Debt counsellors will negotiate with creditors to lower your monthly instalments, making the debt payments more affordable and freeing up some much-needed cash flow.
- Protection from legal action: Debt review reduces the risk of legal action by creditors, protecting the assets of the indebted person. Consumers need to keep in mind that creditors are not always legally obligated to stop their pursuit of repayments during the debt review process, particularly where legal action has started before the debt review has commenced. Therefore, sticking to the repayment plan is important.
- Single monthly payment: You will make one consolidated monthly payment to a payment distribution agency (PDA), which then distributes the funds to your creditors.
- Lower interest rates: In certain cases, debt counsellors can negotiate with creditors for lower interest rates, which can result in savings in the long run.
Disadvantages of debt review
- Additional fees: Debt counsellors will charge a fee for their services, which could add to your overall debt.
- Lengthy process: Debt review process can be a lengthy, sometimes taking several years to complete, depending on the debt amount.
- No new credit: While going through the debt review process, you cannot enter into any new credit agreements, except for a consolidated loan under specific circumstances.
- Court order: The repayment plan becomes a court order which means that you are legally bound to adhere to it. Failure to stick to the repayment plan can result in further legal action.
Debt consolidation
Sebastien Alexanderson, Head of National Debt Advisors, said that debt consolidation involves taking out one large loan to settle multiple smaller debts including credit cards, store accounts and personal loans.
"This combines all debts into a single payment, making it easier to manage," Alexanderson said.
"For example, someone with four store accounts totalling R80,000 could consolidate them into one loan. While this sounds convenient, it’s important to know that interest rates on consolidation loans in South Africa can range between 18.25% and 28.25%, which might lead to higher overall costs, especially if you stretch the repayment term."
Advantages of debt consolidation
- One payment: It simplifies your finances, making it easier to keep track of just one payment each month.
- Lower interest rate: If the new loan comes with a lower interest rate, it could also lower your monthly repayments, giving you some breathing room in your budget.
- Credit utilisation ratio: The lowering the balances on your credit cards or closing smaller debts can improve your credit utilisation ratio, which can positively impact your credit score over time. However, the benefit of lower monthly payments often depends on the interest rate and repayment period. Extending the loan term might reduce the monthly payment but could cost you more in the long run.
Disadvantages of debt consolidation
Alexanderson said that both debt review and debt consolidation come with their own challenges.
While simplifying debt repayments, the process of debt consolidation does not address the root problem of over-indebtedness.
Debt consolidation requires financial discipline because if you continue spending on the accounts you have cleared, you could find yourself back in deeper debt.
Impact on your credit record
While debt consolidation and debt review are options to solve your debt problem, there could be some implications for your credit record.
Gaoaketse said that entering debt review will negatively impact your credit record and credit score.
"You will be listed as under debt review with credit bureaus, which may make it difficult to obtain new credit in the future and may also affect the interest rate charged by creditors," Gaoaketse said.
With debt consolidation, there is a different impact.
Alexanderson said: "Taking out a new loan may initially lower your credit score because of the credit inquiry and the increased credit utilisation.
"However, if you consistently make your payments on time and don’t add to your debt, your score can improve over time. Missing payments on a consolidation loan can harm your credit."
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