Basic Economic Principle: Only a fool replaces short-term debt with long-term debt.
Wow, that's quite a harsh statement, but a statement that will stick in your mind when the financial pressure is so high and there just doesn't seem to be a way out.
Consolidating your debt into your mortgage loan just seems to make so much sense when you're under pressure to pay the bills, but is this a wise decision?
Is making that five year personal loan at the bank going to solve my current financial difficulty or am I setting myself up for a fall?
Lets compare the advantages and disadvantages of exchanging short-term debt for long-term debt.
Advantages of Long-Term Debt replacing Short -Term Debt
Most of the advantages are real when considering one's emotional state, but the danger is that it's a
advantage for today and a disadvantage for next month or next year, basically postponing the inevitable and more than likely setting you up for increased stresses.
Disadvantages of Long-Term Debt replacing Short-Term Debt
Real life example:
'Peter' lives in Khayelitsa. He owns a home worth R500 000 with a bond of R150 000. He's monthly
payments towards debt is R12000. 'Peter' is offered an opportunity to clear his credit record and to reduce his monthly expenses.
How it works: The company selling the product contracts with 'Peter' to settle the bond on his
home and his debt. In exchange 'Peter's' monthly expense on debt is reduced from R12000 to about R4500. After clearing 'Peter's' credit record, the company assists 'Peter' to get a new bond on his home.
So far this sounds great to 'Peter'. He gets to keep his house, his stress is reduced, and he has money to spend. What 'Peter' doesn't understand is that for the period he's waiting for his name to be cleared, he is paying an interest of 28% per year. This excludes the administration fee. The new bond is then registered with fees for the bond originator and the lawyers cost plus the bond fee.
An original short term debt of about R30000 has now increased to over R100 000 and interest is charged on the increased bond over a term of 20 years.
Is 'Peter' really better off?
If 'Peter' continues paying as much as he can on the debt, then this can be an option to consider. Unfortunately for 'Peter', he now has a clean credit record and he can get three new credit cards and buy a new car which he's always dreamed of. He can also upgrade his furniture and replace some of the old appliances.
Within 18 months 'Peter' is in a worse financial position than he was before he made the long term debt and there just doesn't seem to be a way out...
Is there a better option?
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