According to Bank Windhoek’s Credit Officer, Anton Smit, in tough financial times people often turn to debt consolidation to find a solution to their monthly cash-flow shortage.
Smit said that debt consolidation is defined as taking out a new loan to pay off a number of liabilities and consumer debts, generally unsecured ones.
He however said, there is the myth that debt consolidation will be the answer to your problems and, then there is the truth, “Myth: Debt consolidation saves interest, and you have one smaller payment. Truth: Debt consolidation is an indication of over-indebtedness and treats only the symptom,” he explained.
According to Smit, “With debt consolidation you are only extending the problem, because you think you solve the debt problem, but in reality the debt remains, as do the habits and behaviour that caused it. You cannot borrow your way out of debt. You cannot get out of a hole by digging out the bottom”.
“Having debt is not the problem; it is the symptom that is at issue. Debt is the symptom of overspending and under saving. More often than not, debt consolidation does not work or addresses the root problem,” he added.
Smit said that in most cases it has been proven that, after someone consolidates his credit card debt, the debt grows back and this he said is as a result of not having a plan to either pay cash or not buy at all.
“The game plan also does not include saving for unexpected expenses which will also become debt,” he added.
“Debt consolidation seems appealing because there is a lower monthly payment and a better rate can be negotiated. However, in almost every case the lower payment exists, not because the rate is actually lower, but because the term is extended. If you consolidate short term debt, you get a lower payment, but if you stay longer indebted, the lender receives more interest, which is why some lenders are in the debt consolidation business,” Smit advised.
“It is normally a bad idea to pay a short term acquisition, like clothing, over a long period. The clothes might already have been thrown out, but you are still paying it off,” he added.
Meanwhile, Smit said that the answer is not the interest rate; the answer is a total money makeover. According to him, the way to get out of debt is by changing bad financial habits.
“You need to commit to getting a written plan, sticking to it and start paying off the debt. Live on less than you make and don’t spend what you can’t afford. Dealing with financial problems can be stressful, which is why most people need help getting through it. Speak to your bank before your cash flow is in dire straits and think twice before you consider debt consolidation,” he concluded.