Tips from the National Responsible Credit Helpline: Debt Traps to avoid

The National Responsible Credit Helpline which is offered free to consumers by the NDMA received and made 14461 calls and finalised 2510 enquiries for the first two quarters of 2013. Consumers can call the helpline to enquire about any credit related matter.

Through enquiries handled, the NDMA has identified several credit products that seem attractive to consumers but can be a serious debt trap and cause financial difficulties if not well explained by credit providers and used responsibly by consumers. Consumers are encouraged to call the NRC Helpline before they take up these products or when they are already experiencing problems with them.

These products include:

Short Term Loans

Short term loans, including pay day loans offer relief to consumers who experience a short term cash flow problem. These are usually considered the “the poor man’s overdraft” To qualify for an overdraft, one has to have a cheque account and the minimum income required to qualify for a cheque account is R10 000. Most low income consumers therefore do not have this facility and therefore have to depend on short term loans.

These loans are usually for small amounts of between R2000 and R8000 payable over a period of six months. These are categorised as short term loans by the National credit Act and they attract an interest rate of 5% per month. In addition to interest, credit providers are allowed to charge an initiation fee, monthly administration fee and credit life insurance. When all these are added up, an R8000 loan over six months can end up costing the consumer an additional R2400 just in interest.

If not handled properly short term loans can keep a consumer in a never ending debt spiral as most consumers end up revolving these loans monthly. This means that instead of paying off the loan, the consumer pays and then withdraws the same amount every month attracting additional interest and fees.

Consumers who take out short term loans must watch out for excessive credit life insurance and ensure that they understand the benefits of the insurance, terms and conditions as well as the claims process. They must also compare interest rates charged by different credit providers before taking up the loan. Saving for emergencies and proper budgeting, which involves managing monthly cash flow and expenses can reduce the reliance on these loans.

Smaller lenders are not required to register as long as they meet the thresholds set in the National Credit Act regarding the number of credit agreements they have or the amount of credit they have issued. Even though they are not required to register, they still have to comply with the National Credit Act. However, sometimes consumers take loans from smaller lenders who charge unlawful interest rates and use unlawful methods to collect their debt. These involve taking the consumer’s ID document, bank card and pin number. Some even take pension cards. These methods of collecting debt are illegal and should be reported to the National Credit Regulator. Consumers must also ensure that they are charged the correct interest rates.

Balloon or Residual Payments

These products allow the consumer to afford a more expensive car as a portion of the capital amount is deferred until the end of the term of the agreement. For example a consumer who wants to buy a car worth R300 000 but cannot afford the monthly instalments can agree to pay instalments on R240 000 and pay off the R60 000 as a lump sum at the end of five or six years depending on how long the term of the agreement is. Interest is charged on the full amount but the instalment becomes lower. At the end of the term a consumer has to pay the outstanding lump sum or have the lump sum restructured over another 6 or 12 months. Additional interest is then charged on the restructured amounts. If a consumer does not qualify for the refinancing and they cannot pay the lump sum, the car will be repossessed and auctioned and if there is a shortfall, the consumer is liable for the shortfall.

The restructuring of the residual might be declined for the following reasons:

a) A record showing slow or irregular payments;
b) A negative credit bureau report;
c) Any judgements or other adverse records like administration and sequestration;
d) Being under debt review; and
e) Lack of affordability.

In a case dealt by the NDMA a consumer purchased the vehicle in 2006 at prime rate minus five over 60 months with a balloon payment of R106 000 which reduced the instalment drastically compared to its rivals in that class. The lower instalment and other contributing factors influenced her choice of that particular model.

The problem started when her five year contract expired in 2011 which meant that the full outstanding balance of the balloon payment of R106 000 was due and payable immediately. She therefore, entered into negotiations with the creditor to restructure the outstanding balance. The credit scoring declined due to a record of late payments. While she never skipped payments during the existence of the contract, she somewhat paid a few days late as and when she received her income. It was for this reason that the creditor commenced with the enforcement action and demanded the full payment of R106 000 plus interest or the consumer to surrender the car.

When approached by the NDMA, the creditor was adamant that there was no basis to allow the consumer to retain the car as the contract had expired and she did not meet the restructuring criteria. After intense negotiations focusing on the merits and benefits of repossessing and auctioning the car vs restructuring the repayment, the creditor provider, although not legally obliged, agreed to cancel the legal action and accept a repayment proposal from the consumer to keep the car and settle the full amount in seven months on condition that she provided proof of comprehensive insurance of which the consumer did.

Cash Back Deals

Many credit providers advertise cash back deals. This is where the consumer is offered a lump sum amount if they buy a certain model of a car. The amounts range from R20 000 to R50 000 and seems very attractive. Usually consumers will buy an expensive car just to get the cash back. If the car is within the consumer’s affordability and the cash back is used to settle debt then this might be better but most consumers consume the cash back and are left with long term debt they cannot really afford.

A typical example is where a consumer who is not over indebted but has many small credit agreements purchases a vehicle for R200 000 and receives a cash back amount of R20 000. The consumer uses the R20 000 for “bells and whistles” for the vehicle e.g. rims, bigger tyres or a sound system instead of using the cash received to settle credit agreements. This is unwise spending as not paying off existing debts when one comes into cash often puts consumers in a worse off situation.

Credit with “Benefits”

Some credit providers offer a range of benefits that are bundled with the loan. These benefits can include cash advances for every six months of good payment behaviour, loyalty points, holidays and cash discounts. Some offer free coffee and magazines. While consumers are enticed by these benefits, they forget to weigh these against the actual cost of the credit. Consumers often incur more credit in order to qualify for these “benefits.”

In a case dealt with by the NDMA, a consumer applied for a consolidation loan of R27 793.20 payable over 36 months. He was then offered credit life policy, rewards and benefits which enticed him. These rewards and benefits worked as follows: for every instalment paid, consumer would get a refund of R320.00 named monthly cash support and R2 647.26 annual needs pay-out. All the above pushed the total balance outstanding to R85 384.44 when interest and other charges were added. The instalment was R2 371.79. After the NDMA assessed the case, it asked the consumer to request the credit provider to cancel the rewards and benefits amounting to R27 404, as the credit provider had indicated that these are not compulsory. Once this was done a settlement of the benefits already advanced was negotiated the total outstanding balance was reduced to R22 723.20 and the monthly instalment to R1 417.

Consolidation Loans

If a consumer is in serious trouble with high interest rates, high monthly payments (that they are having trouble with already), and too many commitments, a debt consolidation loan might help. Combined with a budget it can be used to pay off all of debt with concessions from credit providers. It should however never be seen as an easy solution and careful consideration should be given to both instalment, period of repayment and interest!

People, who are diligent and committed to reducing their indebtedness and have a lot of small debts that takes up a lot of their monthly cash flow, can apply for a consolidation loan. Consumers benefit by receiving concessions such as reduced interest rates, lower monthly instalments through negotiations with creditors and by having a clearly defined recovery plan. If consumers approach a registered financial institution for a consolidation loan, they will in some instance assist with the direct payment of some or all of the credit providers. There is however some credit providers that the consumer will need to pay directly and the consumer will need to withstand the temptation to use the money for other expenses and not to pay in line with the plan devised.

Once a consumer has taken out a consolidation loan, their responsibility includes: understanding the impact (how long, interest rate and monthly repayment) of the consolidation loan, commit to pay debts in line with the recovery plan, not to get tempted to use money for other expenses or luxuries, regular payments in line with the loan requirements, keeping tight tabs via a budget on expenses to ensure available funds are used wisely and not enter into more credit whilst rehabilitating.

Positive Effect:

  • Servicing only one loan takes the pressure off the consumer as managing multiple payments and accounts can be overwhelming and time consuming.
  • Debt consolidation can have a positive effect on your credit score as several accounts will appear to be paid off.
  • Timely repayment of new credit will also have a positive effect on the consumer’s credit record in the long term, it is important to keep up to date with payments in order for the credit score to improve.
  • It is better to borrow against your equity, than it is to apply for new credit repeatedly in order to take advantage of lower interest rates.

Negative Effects:

  • Incurring more debt after consolidating existing debt will result in the same debt stressed position as before consolidation;
  • It is important to keep up with your debt consolidation loan payments, and any other credit payments that consumers are required to make, otherwise this will have a negative impact on the credit score.
  • Closing accounts after consolidating the debt can have a negative impact on the credit score. Never close the oldest accounts because they provide the longest credit history.
  • Consumers may also want to wait until the debt is paid off before closing accounts. This is because the overall available credit will decrease, yet the debt level will remain. That makes it look like the consumer has "maxed out," and are therefore a high risk.
  • Be disciplined if this is the choice and understand the consequences if the account is used especially store and credit cards.

Whilst paying only one loan takes the pressure off consumers as managing multiple payments and accounts can be overwhelming and time consuming it may also lead to:

  • temptation to use the money for consumption instead of settling the intended debts;
  • re-using the credit available on the accounts settled if they are not closed and
  • to ask for more money than what is needed to settle debts.

There are multiple options available instead of consolidation loans and the sooner a consumer identifies that they are in a downward debt spiral the more likely it is that there will be more solutions available to the consumer. Consumers can contact the NDMA to discuss alternative remedies for their debt stress

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