The debt consolidation loan is apparently riding the wave of a surge in unsecured lending credit – credit cards, personal loans and store cards – that has hit South Africa.

Debt consolidation loans offer a chance to pay off all your debts. It gets all your current creditors off your back while giving you only one instalment to service. Usually the instalment will be less than what you’re currently paying on all your debts because the debts will be spread out over a longer period. There are also some cost savings – instead of monthly administration fees and other charges on each of the credit agreements, you now only have one agreement.

Short-term

In June last year, African Bank introduced a debt consolidation product, which reached R1bn in sales by August. Old Mutual Finance, which has the financial backing of Standard Bank, has also aggressively moved into the space with its “flagship product”, My Money Plan. It offers a loan of up to R120 000 over a maximum of three years to settle all your short-term debts. The interest rate on the loan will be between 17% and 32%, depending on the state of your credit record.

There are a number of requirements – you need to have worked for a year with the same employer, who must have been in business for at least three years. Old Mutual Finance will pay off all your debts like store and credit cards, but crucially – while it will advise clients to do so to avoid running up more debt – there isn’t a requirement to close your accounts.
“Our agreement provides that we can stop further advances where customers take up other loans after having concluded loans with competitors. In practice it’s difficult to do that where the client’s reasons for deviating from the plan is not known to us,” says an Old Mutual representative.

Treat the disease, not the symptoms

The biggest problem with consolidation loans is that it only treats the symptoms of debt dependency.

“Most consumers don’t use the freed-up money from paying a reduced instalment to pay off the loan quicker and usually end up taking out further debt which traps them in a debt spiral,” says the CEO of the National Debt Mediation Association, Magauta Mphahlele.

According to US research, more than 70% of people who consolidate their credit end up with the same or a higher debt load within two years. For most people, the reprieve of having a lower instalment and a better cash flow will lull them into more spending.

Also, because your debt is stretched out over longer period, even if you pay a lower average interest rate, you’ll end up paying more for a debt in the end. And to make matters worse, some of the financial institutions are apparently making use of consolidation loans to lend additional amounts to clients.

“They tell the client: ‘Look, your monthly instalment will now be much lower – you’re used to paying X a month for all your debts, why don’t we lend you more money, which will still only mean you’ll be paying X every month’,” says one debt industry expert. Consumers end up with much bigger debt loads than they started with.

New credit

According to African Bank, only 40% of the capital disbursements of its consolidation loans were in fact used to settle third party payments – the rest was new credit. Old Mutual Finance, for example, offers its My Money Plan clients regular “cash support” payments four or five times a year as part of the consolidation loan. But the group denies adding to financial strain, saying its customers who stick to their debt consolidation plan will become debt free “so that they may save and invest into their future”.

Alternatives to debt consolidation will be negotiating restructured payments with the credit provider directly and going under debt counseling – which will also mean lower payments, and you won’t be able to take on more debt.

Defaults on consolidation loans could place more strain on the courts, which are already facing huge pressure, says the industry expert, who didn’t want to be named. He says there is nervousness about fallout from the spike in unsecured lending last year and new debt products – African Bank sold loans last year with repayments that will only start in March or April this year.

African Bank itself said in an analyst presentation last year that it was “performing analysis to better understand whether there are pockets of risk emerging” in debt consolidation.

“Initial analysis indicates nothing deep… but a second wave of recession may change this…”