Over-indebtedness occurs when a consumer is unable to repay all financial obligations in a timely manner or where total debt repayments exceed net income after living expenses have been paid for.
Many people are uninformed about what the pros and cons are when it comes to debt review or consolidation, the two financial instruments that can lessen your debt pile.
Debt consolidation and debt review help you reduce your debt load, but they do so in different ways and by using different strategies.
With debt consolidation, multiple loans are all rolled into a new consolidation loan that has a single monthly interest rate.
With debt review, either you or a credit counsellor negotiate with your creditors so that you can pay a lower amount than what you owe, often in a lump-sum settlement.
John Manyike, head of financial education at Old Mutual, says it is never easy to admit when financial matters go wrong, and that instead of tackling their debt problem head-on, many people would rather bury their heads in the sand and hope that the problem will go away.
“While a positive financial future may seem far away, it may not be if you take the necessary steps you need to empower yourself with knowledge about available financial tools. Enabling a new, positive future begins with taking the first step and meeting with a debt counsellor,” he said.
What needs to be understood about the debt review process, Manyike adds, is that:
- Debt review is a legal process that cannot be exited until all debt is paid;
- If a judgment for payment has already been issued against you, this cannot be included in the debt review process; and
- If you receive notification that legal action is to be taken against you, you have 10 days to approach a counsellor to avoid this happening.
Cons of debt review:
- You cannot enter into any new credit agreements (you cannot apply for any loans or finance);
- You pay additional fees (debt counsellor fees, payment distribution agency fees); and
- You will have a negative credit profile.
“What is most important, however, is that you select a debt review consultant carefully and review their credentials so that you get the best service possible,” said Manyike.
Debt consolidation:
Debt consolidation also has its advantages and disadvantages. One of the benefits is that you make a one-off single payment every month instead of several individual payments.
You can only pay one interest rate, giving lower monthly repayments.
Some of the disadvantages of debt consolidation, according to the National Debt Advisers are:
- High fees and interest rates.
Borrowers with excellent credit scores may be offered better rates. But otherwise expect high upfront fees. Plus, interest rates can increase.
- It is expensive in the long run.
It takes 10 to 20 years to repay a debt consolidation loan. All the while, interest is piling up – so you end up spending a lot more on debt.
- The illusion of debt being paid off. Having just one loan to pay off creates the illusion that you have less debt to pay off. You still owe the same amount of debt, it’s just all in one place.
You may be tempted to use credit cards again after they’ve been paid off; and
- It does not provide debt relief.
Debt consolidation does not reduce the amount of debt you owe.
Smaller, short-term debts are paid off with one large long-term debt. This only has the effect of combining your debts, not reducing them. Thus, over-indebted consumers cannot benefit from consolidation.
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