Dangers of debt consolidation without a plan

With South African households spending an average of 40 percent of their income on debt repayments, many homeowners are looking at consolidating their debts into their home loan accounts, which carry a much lower rate of interest than most other forms of credit.

But they should beware of jumping out of the debt frying pan and into the fire, says Shaun Rademeyer, chief executive of mortgage originator BetterLife Home Loans.

“Debt consolidation using your home as security should only be undertaken by very disciplined borrowers. And there’s no point in even starting a debt consolidation programme unless you set manageable goals and know that you can live comfortably with the steps you take in order to achieve them.”

He says that if the capital component of a home loan has been reduced and is now well-below the market value of the property (which is generally the case if the owners have lived there for more than five years), it could be worthwhile to re-access a portion of the original loan and use this to pay off debts that carry a higher interest rate.

“Alternatively, if you own a property where the value has increased substantially since you took out your mortgage you may want to consider refinancing by taking out a completely new, larger loan, or a ‘further advance’ on your original loan and using the additional amount available to settle other debts.

“However, if you do this you should aim to pay off the additional amount you have borrowed as quickly as possible, and get you mortgage liability back to where it was.

“Simply borrowing the extra finance and extending the period over which the mortgage has to be repaid isn’t really saving – and could actually cost you more in interest in the long run.”

In addition, you should know that there are costs associated with extending your bond, such as a valuation fee, bond registration fee and legal fees, and that if you don’t have cash to cover these but decide instead to add them to your debt, you will be paying interest on them over the life of the loan.

And of course you should not take on any new debt or just run up your credit card balance again once you’ve consolidated all your old debt. You will already have a bigger home loan repayment obligation, and if you are unable to pay that as well as a new credit card instalment, for example, you will be putting the roof over your head at risk.

What you should rather do, he says, is take all the money you have been paying off on other debts every month and add it to your new mortgage repayment, to quickly reduce the capital balance of the loan again. In this way you might even end up paying your home loan off faster than anticipated and save yourself many thousands of rand in interest.

And before you even consider consolidating, Rademeyer says, you should establish what interest rate you would be charged on your increased bond amount as this could make all the difference to the viability of their plan. And you could seek help from a reputable mortgage originator that will negotiate on your behalf to ensure you get the best loan option to suit your particular financial circumstances.

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