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

1. Lower monthly commitments - Instead of paying R5000 per month for a R100 000 loan I can know pay R900 per month over 20 years.This loosens up cash flow for other monthly expenses.
2. One monthly commitment instead of 10 or 15. I now only have to talk to the bank instead of all those creditors breathing down my neck.
3. Reduced level of stress.
4. Lower interest rates.

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

1. Higher finance costs -The short term debt of R100 000 as above sample, will most probably not cost more than R30 000 in interest etc that I'm currently paying off on. That same debt over 20 years will cost more than R110 000 in interest alone, excluding the administration and bond originating cost etc.
2. The 'problem' that caused the debt in the first place is still not resolved. Debt is a symptom of something else and not the problem. What happens next is with the additional funds available, 90% of the people making use of long term debt to pay short term debt, make more short term debt.
3. We cannot foretell the future. By using debt we take from the future to use now. I assume that I'll be earning money in 15 years time to be able to pay the monthly installment. What if I'm unemployed at that stage?
4. One is usually able to make more long term debt than what my short term debt was, so I can now purchase some more items with the extra cash, thus increasing my total liability and risk.
5. Assets, like your home, are used as security against the new debt. My home is then put at risk, whereas the short term debt is most probably for consumable item such as food or clothing.

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?

Please feel free to join in this discussion by commenting at the bottom of this page or join us in our
online personal financial coaching sessions. www.solutionfinder.co.za