Here’s when you should consolidate short-term debt into your bond
The average South African household is spending up to 40% of its income to furnish debt. What’s more, more than half (52%) of South African borrowers are more than a month in arrears.
According to Shaun Rademeyer, CEO of BetterLife Home Loans, this has meant that more financially strained consumers are considering consolidating their debts into their home loan accounts.
“If the capital component of a home loan has been reduced and is now well below the market value of the home it could be worthwhile to reassess a portion of the original loan and use this to pay off debts that carry a higher interest rate,” he explains, adding that this must be done with caution though. “Debt consolidation using your home as security should only be undertaken by disciplined borrowers. 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.”
Rademeyer advises, though, that homeowners should pay off the additional amount that has been borrowed as soon as possible. “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,” says Rademeyer. “Homeowners should rather take all the money they have been paying off other debts every month and add it to their new mortgage repayment, in order to quickly reduce the capital balance of the loan again.”
Andrew van der Hoven, head of home loans at Standard Bank, says that the bank has noticed an increase in the number of these applications since the start of 2016. “Debt consolidation into a bond can only be done on existing home loans as the equity that has been acquired over time is utilised to consolidate,” explains van der Hoven. “It should be noted, though, that we do not encourage or promote settling short-term debt with long-term debt.”
Rademeyer and Van der Hoven agree that the consolidation should leave the consumer in a better financial position than before. The consumer should be able to maintain their expenses and living costs without falling into the same debt trap once more. “Consumers should not take on new debt or just run up their credit card balance again once the debt has been consolidated,” warns Rademeyer. “They will already have a bigger home loan repayment and if they find themselves in a situation where they are unable to pay that as well as the new credit instalment, they will literally be putting the roof over their head at risk.”
Ewald Kellerman, chief risk officer: mortgages at Absa retail and business banking says that even though there are benefits to be gained from lower monthly installments as a result of debt consolidation into a home loan the potential drawbacks often outweigh these benefits.
“Short-term debt may be structured in a way that would take much longer to pay off,” explains Kellerman. “An example of how this could negatively affect a customer is where, for instance a vehicle finance account is consolidated and restructured over 20 years, and the car needs to be replaced sooner. The customer would not have finished paying off the debt, but would already need to purchase a new asset.”
According to Van der Hoven the bank follows a stringent process so that exactly these kinds of situations are avoided. “A detailed affordability assessment is conducted taking all the customer’s income and expenses into account by utilising payslips, bank statements, credit bureau information and conversations held with the customer,” he says. “We also consider whether the customer has been assisted through the process before and whether they have made a concerted effort to change their lifestyle or whether they have continued in the old ways which might have got them into this position.”
Kellerman says that an applicant who is not distressed and qualifies for further lending will be considered for this method of debt consolidation. “This would require that the customer can afford the new installment, qualifies based on credit history and has enough equity available in his/her property to consolidate the debt,” he adds.
Rademeyer says that, even if a bank approves the extension, consumers must keep in mind that there are additional costs that, should they not have the cash, would need to be furnished by the bond extension too. According to Van der Hoven some of the costs are covered by the bank and others by the customer (will be included in the bond). “Provided sufficient equity is found with the updated valuation, for which the bank pays, and if affordability is in order we will proceed to approve the bond extension for consolidation,” he explains. “An attorney will be instructed to facilitate the registration of the further bond, cost of which is for the customer’s account but will be included in the bond.” He adds that the attorney will also facilitate payments to all creditors, with no funds paid to the consumer.
The concern here is this: The debt trap is real. Consumers finding themselves financially strained will rejoice at the breathing room this type of consolidation offers them but it is very easy to fall back into the same damaging spending habits, racking up maxed-out credit cards, store credit and personal loans and overdrafts within months of the breathing period. Are banks doing enough to educate their customers on the dangers of these financial actions?
Van der Hoven believes that Standard Bank is: “All the consolidations facilitated through this process are done so with detailed conversations between the debt restructure manager and the customer,” he says. “The process follows sound credit principles in terms of managing ones’ income and expenditure responsibly.”
He adds that the in-depth interview with the applicant is conducted around issues such as: What contributed to them finding themselves in this situation, what they can do in the future to prevent the same thing from happening, the importance of saving for unforeseen circumstances, and the importance of proper financial planning.
According to Absa’s Kellerman this method of debt consolidation only makes long-term sense if the customer can display a good understanding of the factors behind the over-indebtedness in the first place and has taken definite steps not to repeat the financial decisions that got them there in the first place.
He makes mention of the fact that Absa regularly publishes information brochures and educational material aimed at guiding customers in practicing sound credit principles. “We’ve discussed the challenges of affordability and the dangers of over-indebtedness with our customers and first-time home buyers in our publications in detail,” he says. “Significant discipline is required from the customer not to borrow again and only if the consolidation provides a better interest rate without term extension is it a good idea.”
It seems that most industry players can agree that it is rarely a good idea to consolidate short-term debt into long-term debt. FNB does not offer their home loan clients this option while Van der Hoven says Standard Bank would only consider this method of consolidation if it is the only way to restore the customer’s financial well-being, while Absa believes that all criteria must be stringently met, and even then it is up to the customer to make it work for them long-term by managing their spending carefully to avoid new debt.