Is a debt consolidation loan a good idea for you?

Debt consolidation loans are often marketed as a one-size-fits-all solution for managing debt. They promise to simplify your finances by combining all your debt into a single loan. If you're considering a debt consolidation loan, it’s crucial to understand the pros and cons as well as the risks involved. Let’s dive into whether a debt consolidation loan is really worth it.

What is a Debt Consolidation Loan?

A debt consolidation loan allows you to combine multiple debts—such as credit cards, personal loans, and store accounts—into a single loan with one monthly payment. While this sounds appealing, the risks can outweigh the benefits if you don’t fully understand the terms and consequences.

Is debt consolidation worth it?

Debt consolidation loans aren’t inherently bad, but they’re not the best option for everyone. Before deciding, ask yourself these questions:

• Am I comfortable with the total cost of the loan over time?
  Calculate the total interest and fees to see if the consolidation loan actually saves you money.
• Have I addressed the root cause of my debt?
  Consolidating without changing your financial habits could lead to more debt down the line.
• Can I manage the monthly payments?
  A lower payment is tempting, but make sure you can handle the long-term commitment.
• Would I even qualify for a loan?
  Remember that a debt consolidation loan involves applying for another loan. You are not guaranteed to be approved, especially if you've already missed some of your debt repayments.

Disadvantages of debt consolidation loan

Here are some key reasons why taking out a debt consolidation loan may not be the right move:

1. You May End Up Paying More
   Debt consolidation loans often come with longer repayment terms. While your monthly payments may be lower, extending the loan period could mean you end up paying more interest over time. The total cost of your debt could increase significantly, leaving you in a worse financial position.
2. It Doesn’t Address the Root Cause of Debt
   Consolidating your debt doesn't solve the underlying issue that caused your financial struggles in the first place, such as overspending or lack of budgeting. Without addressing these habits, you risk accumulating more debt after consolidating, leading to an even bigger financial problem.
3. Hidden Fees and Costs
   Some debt consolidation loans come with high upfront fees, hidden charges, or penalties for early repayment. These extra costs can eat into any savings you hoped to gain by consolidating your debt, making the loan more expensive than expected.
4. You Could Damage Your Credit Score
   Taking out a new loan could temporarily lower your credit score, as it adds a new line of credit to your report. Additionally, if you miss payments or struggle to manage the consolidated debt, your credit score could take a long-term hit.
5. Risk of Losing Assets
   If you opt for a secured debt consolidation loan, such as one tied to your home or car, you put those assets at risk. Failing to make payments could result in the loss of your property, which would be far more damaging than unpaid credit card debt.

FAQs About Debt Consolidation Loans

Can Debt Consolidation Help with High-Interest Debt?

Yes, but only if you can secure a loan with a lower interest rate than what you're currently paying. Keep in mind that even with lower rates, long loan terms could cost you more overall.

Will Debt Consolidation Affect My Credit Score?

Initially, taking out a new loan could lower your credit score. However, if you make timely payments, your credit score could improve over time. If you already don't have a good credit score, you might not be able to be approved for a debt consolidation loan. 

Are There Any Fees for Debt Consolidation Loans?

Many debt consolidation loans come with upfront fees, which may include application fees, origination fees, or early repayment penalties. Always read the fine print to understand the total cost.

What Are the Alternatives to Debt Consolidation Loans?

If debt consolidation loans don’t sound like the best fit for you, there are other ways to manage and reduce your debt. These alternatives can provide real relief without the potential pitfalls of debt consolidation.

1. Debt Review/Debt Counselling

In South Africa, debt review is a legal process that helps over-indebted consumers manage their financial obligations. With the help of a registered debt counsellor, you can negotiate reduced interest rates and extended payment terms with your creditors. This process is highly regulated, and once completed, you'll receive a clearance certificate showing that you’ve settled your debts.

Why it’s better: Debt review helps you reorganise your finances, reduce interest rates, and ensure you're paying off debt in a manageable way—without the risk of taking on new debt.

Read more about the debt review process here. 

2. Debt Settlement

Debt settlement involves negotiating with your creditors to pay off your debts for less than the full amount you owe. This could be a viable option if you're struggling to keep up with payments but have some funds available to make a lump sum payment.

Why it’s better: You could reduce the total amount of debt you owe and become debt-free faster, although your credit score may take a temporary hit.

3. Budgeting and Financial Planning

Sometimes the best solution is to address your spending habits and create a strict budget to manage debt. By cutting non-essential expenses, finding ways to increase income, and focusing on repaying high-interest debts first, you can make progress without taking on additional loans.

Why it’s better: It helps you regain control of your finances and instills responsible spending habits without increasing your debt load.

The Key Differences Between Debt Review & Consolidation

How Does Debt Counselling Work?

Debt counselling works by first conducting a thorough assessment of your financial situation. A qualified Debt Counsellor will review your income, expenses and debts to gain a complete understanding of your financial health. Based on this assessment, a personalised debt repayment plan will be created, taking into account your unique circumstances.

Once the debt repayment plan is in place, the Debt Counsellor will then negotiate with your creditors on your behalf. By working with your creditors, the Debt Counsellor aims to reduce your interest rate on your loans, making it easier for you to manage and ultimately pay off your debt.

Meerkat clients have saved up to 50% on their monthly debt instalment!

Throughout the debt counselling process, you will make a single affordable monthly payment towards your consolidated debt. This payment is distributed to your creditors as per the agreed-upon plan. By consolidating your debts into one manageable payment without taking out a loan, you can avoid further damaging your credit score and eliminate the stress of juggling multiple payments.

Who is Meerkat?

Meerkat is dedicated to improving the financial well-being of South African consumers by empowering them to do MORE with their money. Our services include debt counselling, access to affordable funeral insurance, support in kickstarting an emergency savings fund, and credit life cover. 

Simply complete the contact form on our website to connect with the Meerkat team and receive a complimentary callback today.