Help my debt

Debt Review or Debt Consolidation- An Example
You may wonder whether debt review is the right option for you in dealing with your debt. You may have heard stories both positive and negative about debt review but still be unsure if it is the right way to go. Should you look into debt consolidation rather?

How does debt review actually help? Let’s consider these and other questions like: What is the difference between a consolidation loan and Debt Review? What does debt review actually do? Why is consolidating debt not the best answer? Why is the focus only on a lower monthly instalment sometimes a mistake?

Perhaps the best way to answer these questions would be through a practical example of a real consumer who applied for Debt Review after she considered all her options. To protect her privacy let’s call her Claudia.

Claudia, like many other consumers Debt Counsellors meet on a day to day basis, had around 10 times her gross monthly salary in unsecured debt.
This meant that after tax (and other deductions) she was paying around 75% of her salary toward debt each month. This left her with too little to support herself each month.
Each month she had to pay Standard Bank R1600 on her credit card, as well as a payment toward a loan of R1375, Direct Axis R2600 (on her loan of R60 000), Woolworths R1100 and Foschini R900
Total debt obligations each month: R7575
Income after tax and deductions: R9995
This means she only had R 2420 left to cover all her expenses like rent and petrol as well as food and transport etc.

Gross earnings before tax R 12000
After deductions R9995

It is important to note at this point what her interest rates on each loan were, because the maximum interest rates chargeable by credit providers differ from one type of credit facility to another. In fact, credit facilities like credit cards, store cards and overdrafts typically carry a 10% lower interest rate than a credit agreement like a personal loan or consolidation loan as published in Regulations of the National Credit Act.

In Claudia’s case her Direct Axis loan and her Standard Bank loan where the only two agreements at over 30% interest, while her credit cards and store cards where at a lower interest rate, closer to 20%.

Could she maybe go out and borrow more to help ease her debt pressure. Well can you dig your way out of a hole? No. Taking on more debt to cover your debt is a bad idea! Maybe she could consolidate all her debt into one big loan?

It seems like a nice option but it is safe to say that no one would be willing to give her such a loan since she could not afford it. Even if she could, the nett effect would be quite horrific. [Below is a snap shot from a loan calculator which shows what might happen].

At first glance it looks like she will reduce her monthly instalment dramatically from its currently level of over R7500 to a much lower R5200. This seems great but because this would have been a high risk unsecured loan for a credit provider, they would not only want to charge the maximum allowable interest rate (currently at 32.65%), but also demanded she take credit life insurance calculated here at R9 per thousand. Adding the monthly service fee of R57 shows that over the 5 year life of the loan, the total she would repay would be around R313000 in true cost of credit. That is a lot to pay on R120 000 debt. In fact, she would pay about R176 000 in fees and insurance alone.

Out of the first repayment toward such a consolidation loan of R5216, the balance she owes will only come down by R814, and it can be argued that around R4400 (a staggering quarter of her salary will be eaten away monthly in fees and interest. Put in a different way, she could effectively increase her disposable income (available to use funds) by approximately 30% by just getting herself out of debt, a difficult thing to achieve through annual increases one might argue.

Debt Review or Consolidation?
It makes sense not to swap the store cards and credit cards that currently attract around 20% interest for a loan at a ten percent higher interest rate. Debt Review or Debt Counselling which essentially also extends the term, has a huge advantage in that it can often reduce the interest rates. This results in a huge overall saving.

For example, let’s say Claudia rather went under debt review (and paid the fees associated with it). If the Debt Review matter reduced the effective costs and interest to 20% over the same period (which would be a reasonable reduction), it would mean an overall saving compared to consolidating of over R80,000, or the difference between paying back R313,000 or R230,000.

In Claudia’s case this is what she did. When first looking at a debt review plan it was possible to reduce Claudia’s monthly debt repayments down to R3836.27 each month. This meant that she could repay her debts over 60 months (just like if she had gone the consolidation route). She then had enough to support herself each month. However Claudia was very motivated to get herself out of debt, and with some further changes and budgeting advice from her Debt Counsellor she managed to cut her living expenses each month to make R5000 available to settle her debts. In accordance with the recommended industry fee structure, her first debt review payment of R5000 went to the paying the Debt Counsellor, and because there was no opposition to the repayment plan her legal fees were reduced to R750 and the consented order was filed with National Consumer Tribunal. These fees where paid out of the first and second instalments.

Claudia had to pay R222 monthly to the Debt Counsellor and around R134 going to the Payment distribution Agency, or 5% and 3% respectively, but because the credit providers also conceded to removing the monthly R57 service fee on each of the 5 accounts, (totalling another R285 monthly saving) these costs were almost negated. She also ended up paying less on her credit life insurance which saved her a huge amount over time.
Because she was able to pay even more Claudia was able to pay off her debt in record time and get out of debt while saving lots on fees etc. Paying more than the minimum really paid off for her.

So while a consolidation loan (if she had qualified) would have meant a payment of half (rather than 75%) of her income each month the Debt review payment was only R3836 ea month. Even paying less toward her debt through debt review the debt review repayment option cost her less in fees and interest. By Claudia making changes to bring the payment amount higher she got debt free and then had her entire take home salary each month much sooner than debt consolidation could have done.

Debt Review saves you money on Fees & Interest
Interestingly some creditors are willing to lower monthly interest on debt review repayments down to 0% on unsecured credit. So, you not only don’t have to pay the monthly account fee but don’t have to pay any interest as well. This means that these consumers can speedily pay off their debts and re-enter the credit market.

Article by:

Eugene Cilliers

Payplan Solutions
eugene@payplansolutions.co.za