EXPLAINER | What is a debt consolidation loan?

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  • A debt consolidation loan is a personal loan granted to repay other smaller loans.
  • A debt consolidation loan should cost you less in interest than what you are paying on your individual loans.
  • Providers of these loans may either pay off your existing debts or give you the cash to do so.
  • For more financial news, go to the News24 Business front page.

A debt consolidation loan is a loan used to combine or consolidate a number of debts. In other words, you take out one loan to pay off many different accounts or loans.

Paying only one creditor can simplify your financial affairs as you will no longer have multiple loans with multiple payment dates and terms.More important than this, however, is the interest you will be charged on the consolidation loan relative to the average interest you are paying on all your other credit agreements. You should aim to reduce the interest you will pay by using a debt consolidation loan.

Before you take out a debt consolidation loan, work out the total amount you will repay over the term of the consolidated loan and compare that to the sum of the total repayments on each individual loan over their terms.

Micro loans, credit cards and retail accounts are generally expensive forms of credit, since they attract high interest rates.

Using a consolidation loan to settle these forms of debt can make sense if you get a good interest rate on the consolidation loan. However, you must be careful not to extend the period over which you pay off what you owe.

Save on costs

The other advantage of a debt consolidation loan is that you will go from paying multiple creditors a monthly admin fee to paying only one creditor a monthly admin fee, which can also translate into a big saving over time and help make your repayment more manageable.

Paying one creditor may also reduce the premiums you are paying on credit life policies as you will only have one policy instead of multiple ones. \

How it works

Debt consolidation loans are typically offered as unsecured loans over terms from 12 to 72 months. The interest rate on the consolidation loan will be determined in part by your credit score and can be up to a maximum of the repo rate plus 21%. You may also be able to use a secured loan, such as that against property, to consolidate debt but then you need to be careful not to default and lose your asset. 

Where can I get a debt consolidation loan?

Many of the big banks and other credit providers offer debt consolidation loans.

You may not qualify for a debt consolidation loan if you have already defaulted on repayments or had judgments against you.If your credit score is poor, you are also unlikely to be granted a low interest rate on a debt consolidation loan.A debt consolidation loan is, however, the only form of credit for which you may qualify when you are in debt review or debt counselling.

This article was first published on SmartAboutMoney.co.zaan initiative by the Association for Savings and Investment South Africa (ASISA).

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