4 Factors That Can Cause Your Debt Consolidation Plan To Fail
If you are struggling to repay your debt, you may be considering a debt consolidation plan (DCP), or might have already signed up for one.
A DCP helps you to combine all your debts into a single loan. This makes paying off your debts a simpler affair as you do not need to keep track of all the different loan types, interest rates and due dates. In addition, there could be savings on interest charges if your DCP offers lower interest rates than your existing debts.
While a DCP can be an excellent tool to help you pay down your debts faster and in a more disciplined manner, success is not guaranteed. Here are four factors that can cause your DCP to fail:
1. High interest rates
One major advantage of a DCP is being able to consolidate all your debts at lower interest rates. When the interest rate of your DCP is lower than that of your existing debts, you will save on interest charges.
However, if the interest rate of the DCP is higher than that of your existing debts, you’ll incur higher interest charges – that means more money out of your pockets to repay your debts. If the interest rates are too high, you may have trouble servicing your monthly repayments. This can cause you to default on your repayments. In such cases, consolidating your debts will not help you to manage your debts better at all, and you could even incur additional debts from defaulting on your repayments.
If you’re looking for a DCP – whether it’s your first plan or you’re looking to refinance an existing DCP – it’s worth shopping around for the best interest rates.
HSBC currently offers promotional interest rates for their Debt Consolidation Plan, starting at an effective interest rate (EIR) of 7.5% p.a. (for 1 to 7-year tenors). Here’s an example of how much you can potentially save with these interest rates for a S$50,000 loan on a 5-year tenor:
As you can see from the example above, a difference of just a few percentage points in interest rates can translate into savings of thousands of dollars on a S$50,000 loan.
2. Loan tenor
If you’re keen on repaying your debts quickly, taking on a shorter loan tenor may be an appealing option. Knowing that you’re close to being debt-free can be a great psychological boost, and a shorter tenor also means you’ll be paying lower interest charges.
However, a shorter loan tenor may mean higher monthly repayments. Choosing a loan tenor that is too short can backfire if you are unable to meet the monthly repayments and end up defaulting on them.
With HSBC’s Debt Consolidation Plan, you can choose a loan tenor from 1 year to 10 years for a more affordable monthly repayment scheme. The table below shows the estimated monthly repayment amounts with different tenors for a loan of S$50,000:
You can use a tool like HSBC’s Debt Consolidation Plan calculator to estimate the right loan tenor for you based on your affordability.
3. Processing fee
If your DCP imposes high processing fees, you’ll be forking out cash to pay them off instead of putting your cash to where it’s truly needed – actually clearing off your debts.
Most banks charge a minimum processing fee of S$99, up to 1% of the loan amount. Under HSBC’s current promotion, however, the processing fee is waived. That means that you can start repaying your debts immediately as there are zero upfront fees. In addition, you’ll also receive S$100 in cashback upon approval as a welcome gift if you sign up online.
4. Spending and repayment habits
An important factor of success when it comes to debt consolidation is how you manage your debts. Although a DCP can be an effective tool to help you pay down your debts, you will need to change the spending habits that got you into debts in the first place. This includes:
- Making prompt monthly repayments. Always make sure that you pay your monthly repayment in full and on time. Making partial repayment (or missing them altogether) will incur late payment fees and additional interest charges.
- Limiting unnecessary spending. Cutting back on frivolous expenses will certainly help you divert more funds into paying off your debts. That’s easy to say, of course, but much harder to put into practice. To make this resolution stick, set aside money every month to repay your debts and other necessary expenses first – only then can you start allocating cash to fun, guilt-free spending. For great savings on daily expenses, HSBC’s Debt Consolidation Plan comes bundled with the HSBC Visa Platinum Credit Card, which provides up to 5% rebate on daily expenses like groceries and petrol.
- Not using credit cards to pay for things or services you cannot afford. Charging expenses that you cannot afford to repay to your credit card will incur high interest charges. This would mean piling on additional debt when you’re already saddled with existing ones.
If you stick to your old spending habits and miss your debt repayments, the additional fees and charges can end up exacerbating your debt woes instead of alleviating them.
Should you consider refinancing your debt consolidation plan?
While existing DCP customers can seek refinancing after 3 months, you will need to take into account the early repayment fee that is usually chargeable when the DCP is repaid in full before the maturity date. If you are considering refinancing, ensure that the savings you get from the lower interest rate is worthwhile to cover your early repayment fee.