6 Common Misconceptions About Debt Consolidation
Struggling with debt? You aren’t alone: an average of 4,000 Singaporeans every month hit unsecured debt levels 12 times their monthly income or more last year.
If you’ve been searching for debt management solutions, you may have come across a scheme called Debt Consolidation Plan (DCP), whereby your existing debts are consolidated into a single loan. However, the misconceptions surrounding DCPs are numerous, and may dissuade you from considering what could be an effective tool for managing your debts. Here are the top misconceptions:
1. Debt consolidation is the same as bankruptcy
One of the biggest misconceptions about DCPs is that they are the same as bankruptcy, or that it is only for those in dire financial straits.
This is not true at all. Bankruptcy is a legal status of someone who cannot repay debts in excess of S$15,000 and has been declared bankrupt by the Court. If you’ve been declared bankrupt, several restrictions will be imposed on you. For example, you cannot:
- Leave the country without the Official Assignee’s (OA) permission
- Continue in or take up public office
- Be a company director without the OA or the Court’s approval
- Sue any party in court without the OA’s approval
In contrast, a DCP is a repayment scheme offered by financial institutions in Singapore. Under a DCP, all your debts will be combined into a single loan, usually at a lower interest rate. You don’t have to be in dire straits to consolidate your debts; if you have unsecured debt that exceeds 12 times your monthly income, you can take advantage of a DCP’s lower interest rates, even if you can currently afford to pay off your debts.
The only restriction you’ll face under a DCP is that your existing unsecured credit facilities will be closed or suspended, but this is because they will have been consolidated under your DCP. With HSBC’s Debt Consolidation Plan, you will receive the HSBC Visa Platinum Credit Card with an annual fee waiver (as long as the DCP is still in force). While you can’t opt out of the credit card, you can choose not to use it if you do not have a need for it.
2. A debt consolidation plan will ruin your credit score
Your credit bureau report will be updated to reflect the DCP, as is usual for any other credit facility. As long as you make prompt repayments to service your DCP, your credit bureau report will be updated accordingly, without adversely affecting your credit score.
3. Taking on a debt consolidation loan means piling on more debt
A DCP doesn’t incur additional debt – you aren’t adding a loan on top of your existing loans.
Instead, a DCP combines all your debts into a single loan. Here’s how it works: once your DCP application has been approved, your bank will take over all your outstanding balances with other banks, and your existing unsecured credit facilities will be closed or suspended. You will then need to make regular payments to service the DCP.
4. Debt consolidation reduces debt
A DCP doesn’t reduce debt in itself, but it may reduce your interest payments by offering potentially lower interest rates. In Singapore, interest rates charged on credit card debt ranges between 24% p.a. – 27% p.a. With HSBC’s Debt Consolidation Plan, you will be able to consolidate your debts with an Effective Interest Rate (EIR) between 7.5% p.a. and 10% p.a., which translates to huge savings.
To illustrate, let’s say your total debts amount to S$60,000, which you would like to pay off in 4 years. Here’s how the promotional interest rates under HSBC’s Debt Consolidation Plan can help you save:
S$22,000 at 25.5% p.a.
Credit card 2:
S$15,000 at 25.9% p.a.
Credit card 3:
S$13,000 at 26.9% p.a.
Personal Loan (4 years):
S$10,000 at 11% p.a.
**The 5% allowance is provided to cover any incidental charges (e.g. interest and fees payable) incurred.
These figures are for illustrative purposes only.
In the illustration above, consolidating your debts can help you save S$23,190.66.
5. A debt consolidation plan is an expensive, long-term solution
Besides lower interest rates, another advantage of a DCP is that you can choose your loan tenure. HSBC’s Debt Consolidation Plan allows you to repay up to 10 years, with an EIR of 7.5% p.a. for 1 to 7-year loan tenures, and an EIR of 10% p.a. for 8 to 10-year loan tenures. Opting for a longer loan tenure will reduce your minimum monthly payments, making them more manageable. Keep in mind though, that a longer loan tenure means that you will be paying more interest over the tenure of the DCP.
This feature of debt consolidation is sometimes misunderstood as simply moving short-term debt into long-term debt. You may be concerned that consolidating your debts will keep you in debt longer, and that the interest charges that add up over time will offset the low interest rate of the DCP.
However, you need not be worried. Under a DCP, you can always choose a shorter loan tenure if you can afford higher monthly repayments.
In addition, if you’re straddled with high-interest loans like credit card debt, consolidating them under a DCP will still help you save on interest charges – even on a longer loan tenure. Here’s a comparison of the estimated interest payment you may incur from unconsolidated debt and consolidated debt, under different loan tenures:
*This graph is based on the calculations above. These figures are for illustrative purposes only.
In the chart above, the interest payments incurred by consolidated debt are much lower than those incurred by unconsolidated debt. Even if you opt for a longer loan tenure under a DCP, you may be paying less interest than if you had selected a shorter loan tenure without consolidating your debts. For instance, in the scenario above, consolidating your debts under a 7-year DCP will incur a smaller interest payment than that incurred by a 3-year tenure for unconsolidated debts.
6. A debt consolidation plan will guarantee that you’ll get out of debt
Taking on a DCP doesn’t guarantee that you’ll get out of debt. Whether or not a DCP works really depends on how you handle your finances. Clearing off debt (and staying out of it) involves changing the spending habits that got you into debt in the first place. This means weeding out unnecessary expenses, as well as refraining from using credit to purchase items or services you can’t afford.
If you stick to old spending habits while taking on a DCP, you’ll just be extending your financial burdens. Not meeting the monthly payments of your DCP, for example, can incur additional interest and late payment fees. This can cause you to spiral further into debt, instead of alleviating it. However, if you’re ready to overhaul your spending habits, then a DCP can be a powerful tool for helping you manage existing debts.
Is debt consolidation right for you?
DCPs don’t deserve the bad rap they sometimes get. Quite the contrary – for certain people, a DCP can be an effective way of paying down debts while saving on interest charges. If you’re struggling with high-interest debts, take stock of how much you’re currently paying, and compare that to how much you can potentially save by consolidating. Find out how you can get your finances back on track with HSBC’s Debt Consolidation Plan now.