Controlling Holiday Hangovers
Sydney Morning Herald
Wednesday January 1, 1992
THE post-Christmas period is a time of reckoning for people with heavy financial commitments.
For some, who have been carrying substantial debts through 1991 - whether their mortgage, car loan, personal loan, credit card or store card debt - the aftermath of spending over the holiday period brings the realisation that they owe more than they can afford to repay.
Even worse, retrenchment, or perhaps the loss of casual work, can catapult people quickly into a situation of over-commitment.
The pressure can be enormous if you are in arrears on several different debts and the lenders are in pursuit. For this reason, the option of debt consolidation can seem appealing.
The term debt consolidation refers to a transaction whereby a borrower combines a large number of small debts into a single large debt by taking out a new debt for the total amount owed, then repays the original creditors with these "new" funds.
One appealing aspect of this arrangement is that it allows the borrower to concentrate all his or her attention on a single debt.
Another is that the borrower can reduce monthly commitments by taking out the new debt over a longer term.
Also, the debt consolidation loan may be obtained at a lower interest rate than applies on the existing debts.
This especially would be the case if a borrower is able to utilise an existing "home equity" lending facility where his or her equity in a home supports an on-going line of credit. The interest rate on such facilities(presently around 13.5 per cent) is much cheaper than would apply on a personal loan that is taken out specifically for debt consolidation. But, in practice, debt consolidation has several drawbacks. In fact, says Mr Kevin Howard, a financial counsellor for the dial-up support service Credit Line: "There are more minuses than there are pluses."
The principal drawback, he says, is that consolidation "leaves people with the opportunity to go out and build up all those (original) debts again". The temptation to use a newly "cleared" credit card is too great for some, especially if the consolidation loan has given them a sense that they are now in control of their borrowings.
As well, a consolidation loan usually raises the stakes of the borrowing somewhat because most lending institutions will seek security on such a loan, where the original creditors may have sought none. For larger loans, mortgage security may be sought - for example, the Sydney Credit Union would seek mortgage security on a loan around the $20,000 mark, whereas for sums less than this it normally would be satisfied with a bill of sale over a motor vehicle or a similar security.
As Mr Greg Kirk, a solicitor with the Consumer Credit Legal Centre, points out: "Giving a loan in return for security is a leverage for (a lender) to be able to put much more pressure on you later."
While you may have been at some risk of losing your home and other assets, anyway, if bankruptcy proceedings were filed, Mr Kirk notes that mortgage security "provides a much easier method" for the creditor to repossess and sell your assets.
As an alternative to taking security, a lender may require you to supply a guarantor, meaning somebody else takes on the legal liability to repay the debt should you prove unwilling or unable to do so. Says Mr Kirk: "Clearly, if you get a friend or relative as guarantor that is a very serious decision for them to be making and they should be fully informed of the risk involved."
Although you may be able to reduce your immediate monthly commitments by consolidating your debts and taking out a single loan over a longer term, the very fact that you are paying out over the longer term means you will finish paying more.
Mr Kirk says people who have a variety of debts, some short term and some long term, can find the pressure lifts very suddenly once they get the short-term debts out of the way and their total debt instead is being paid off gradually over a much longer term.
He argues that it is often a mistake to consolidate your debt and then finish up paying much more for the short-term debts. If you can hold on, even if only by your fingernails, until you get the short-term debts off your books your financial position will be much better.
Although in lucky cases it may be possible to consolidate at a lower interest rate than you already are paying, often the reverse is the case.
As Mr Kirk says: "The more urgent your need for consolidation, the more likely it is that you will have to pay a high interest rate and thereby increase your problem."
Not surprisingly, debt consolidation is considered a high-risk lending area, and the institutions willing to take it on are those that tend to charge high interest rates anyway. As a Westpac spokesman said: "You are asking a single lender to take on the risky debts of a number of other lenders and why would they want to do that?"
Banks, credit unions and finance companies will all make debt consolidation loans but, in some cases, only for existing customers. As usual, they would need to be convinced of the borrower's ability to repay, and they are likely to be even more stringent than usual since it is repayment problems which have led you to them in the first place.
The rates vary widely between institutions. As an example, AVCO Financial Services (which lends only to existing customers) probably would charge somewhere between 26 and 28 per cent on an unsecured personal loan for $2,000, and a couple of percentage points less if the loan is secured. But, depending on the company's assessment of the risk, it may charge anywhere between 22 and 30 per cent, according to a spokesman.
The Sydney Credit Union would charge between 17.25 per cent and 22 per cent for a debt consolidation loan of less than $20,000, or about 15.5 per cent if the loan was secured by a mortgage. For the latter, though, the real cost of the loan increases by about $500 to cover the cost of valuing the security, registration fees and stamp duty.
Mr Howard of Credit Line also points out that people should never consolidate debts on which they are not paying interest. For example professional fees (doctors, dentists, accountants) and some service fees(electricity, water, gas) do not carry interest charges. "You are better off getting in touch with these (creditors) and offering to pay later."
It is clear that the pitfalls in debt consolidation are many, and so it is an option which should be considered only when all others appear to be exhausted. As Mr Howard stresses, under the Credit Act which applies to most consumer borrowings, the borrower can apply to have his or her payments varied as an aid to getting through a difficult period. This normally would involve a temporary reduction of the payments and an extension of the loan over a longer period.
Most lenders prefer making this type of arrangement rather than eventually being forced to the costly and expensive situation of taking action against a debtor. And it is sensible to make your approach to the lender sooner rather than later, because if you leave it too long your difficulties ultimately will be greater and your credentials as a responsible borrower will be more in doubt.
© 1992 Sydney Morning Herald
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