Are you one of nearly 12 million South Africans using a credit card? Then you are probably very familiar with the interest rate hikes and the high levels of personal debt in the country.
You may have considered using personal loans to pay off debt. You might want to do this to consolidate debt from several cards in one place – which you might think makes it easier to manage.
This strategy can work, but let us explain why it’s not always to your advantage.
How much do you owe – is a loan worth the hassle?
If you owe small amounts on several cards it’s often better to focus on paying these off than taking out loans to pay off debt.
Otherwise, you’re just complicating things unnecessarily, and potentially tying yourself into debt for longer.
Before taking any further steps, make a comprehensive household budget detailing all your monthly expenses.
You may be surprised what this reveals about your spending. It’s easy to get into habits without really thinking about it.
So if there any things on your budget that are costing a lot, and you could afford to live without them, cut them out right away.
Use the amount you’ve saved to pay your credit card bills. Simple budgeting can be a really effective way of getting debt-free.
Will you pay off your debt any faster with a loan?
Another thing to consider if you’re using loans to pay off debt is that the relief from the pressure can be, counter-intuitively, a bad thing.
Even if you close all your credit cards after paying them off, you’ll know that you’ve gathered all your debt in a place where it’s probably growing at a slower rate.
Paying down a loan rather than a credit card is likely to mean lower monthly payments. The temptation is to divert the ‘spare’ money into something you enjoy rather than focusing on paying off the full debt.
Close the credit card accounts as soon as you can if you decide to take out loans to pay off debt. Otherwise you may find yourself digging an even deeper hole for yourself.
Be absolutely honest with yourself – if you think you’d be tempted and spend the money on things you don’t need, using loans to pay off debt is probably not for you.
Don’t get stung by higher rates or a loan’s terms
While credit card interest rates are often higher than personal loans, that’s not always true.
If you’re looking at taking out loans to pay off debt, be very careful. Do the maths, and make sure that the rate of interest you’ll end up paying is, in fact, lower than the interest rate of your credit card(s).
Otherwise, this move could end up costing you a lot of money.
Besides interest rates, it’s also important that you’ve read through all the terms and conditions of the loan. You need to know if you can make extra payments without penalty, for example.
A loan which will let you do this means that you can really whittle away at the interest which would have otherwise built up. A loan which penalizes you for making extra repayments may end up costing far more than paying off the original credit card debt.
Finally, consider the length of the loan. Credit cards have no fixed term – meaning that there’s no point the lender expects you to have fully paid them off.
A loan, on the other hand, will be of a fixed length. You will have to make monthly payments over a fixed number of months, and you’ll likely have a hard time changing that number once the loan has been paid to you.
So you need to be sure you can keep up with the payments – or the lender may chase you for the money, and it may affect your credit score.
A loan could affect your credit score
Missing a payment could affect your credit score, but so can applying for credit. Every time you apply, a mark will be put on your credit report. If you make lots of applications in a short space of time, these will all show up on your report.
Lenders see multiple applications for credit as a sign of financial instability. If you apply for a loan to consolidate debt and are accepted, it’s not so big a deal.
If you keep applying again and again for loans from different providers, you’re actually appearing more and more risky to them after each application.
This can make it much harder to get credit in the future. It’s vital to consider the consequences of this if you’re planning on applying for a mortgage or a large loan for another purpose in the next few years.
You could end up relying on a spiral of debt
Using loans to pay off debt elsewhere is, above all else, just a bad habit.
Knowing you can spin your repayments well off into the future might seem appealing at first, but you’re just prolonging the problem. The interest on your debt will carry on accumulating, and you’ll just owe more and more as time goes on.
You need to break the debt cycle before you can make real progress. The longer it lasts, the harder it is to escape from.
If you are in trouble and need to break the cycle, you can look for a debt counsellor who may be able to help you work out a strategy to cope with your debt.
I’ve thought about it – and I’m going to apply for a loan
We know that many people will read this and decide that a loan is still the best option for them.
That’s up to you. A carefully managed loan can still be to your advantage. But you must have self-discipline for this refinancing strategy to work.
If you’re going down this road, make sure you choose a trustworthy provider. One of the best ways to ensure this is to apply with LittleLoans.
We match customers up with a suitable lender from our trusted panel – all you have to do is fill in one simple application.
