One loan vs many: Is debt consolidation the answer?

People’s spending habits can lead to high debts. (Bernama pic)

PETALING JAYA: For those who are left with only meagre funds in their bank accounts after paying their personal loans every month, debt consolidation can sound like a very attractive prospect.

Debt consolidation is a form of debt refinancing, in which one bank or financial institution takes over a borrower’s multiple loans and consolidates them into a single loan.

The borrower then repays the one loan at an agreed interest rate over a certain period.

But despite the growing popularity of debt consolidation, financial planner Robert Foo warns that there is no such thing as a free lunch.

Speaking to FMT, he said debt consolidation was becoming more common as banks struggle to get new customers due to competition and an insufficient number of credit-reliable people.

He said banks were looking at opportunities to get customers with loans from other banks.

“For example, a person may have loans requiring payments of RM3,000 a month for their personal loans and credit card debts.

“A bank that offers debt consolidation will then offer to take over all these loans. It will offer the customer a monthly loan repayment of say, RM2,000 a month, likely for a longer period and at a slightly higher interest rate.

“The customer will accept it as that’s an extra RM1,000 cash in hand every month.”

But as attractive as debt consolidation was, he said, such schemes only served to treat the “symptoms” of a person’s debt problems.

“The issue isn’t that a person can’t pay off the debts, but why he or she cannot pay off the debts.”

Foo said the root problem was that people weren’t controlling their spending. He said many would often make purchases based on emotions rather than logic, adding that this was evident in the way products and services were being marketed.

“So people must get a comprehensive evaluation of their finances if they are struggling. Are they struggling because their income has decreased?

“Is it because of certain financial decisions? Did they buy an asset they didn’t need or are unnecessarily holding on to it?

“Perhaps it is due to their consumption habits.”

Foo said this was why people needed to have a financial plan to rationalise their debts rather than opting for schemes like debt consolidation, which only treated the symptoms.

“It’s like a sick person who keeps coughing for months. He takes a cough syrup to lessen the coughing, but the source of the cough will still be there and remain undiagnosed.

“It could be a sign of a disease or something in his diet.

“If you find and treat the root cause, the symptoms will disappear. The problem is that many who spend money on things they can’t afford only realise it when they start missing payments.”

Foo added that there was no one-size-fits-all solution as everyone’s financial situation was different.

He warned people against looking for a quick fix, adding that the solution may not lie in borrowing more money.

He also said debt consolidation schemes highlighted the problem of high household debt in the country.

According to Bank Negara, at the end of 2016, the country’s household debt stood at RM1.086 trillion, or 88.4% of gross domestic product.

Of this, residential housing loans accounted for 50.3%, motor vehicle loans for 14.6%, personal financing for 14.9%, non-residential loans for 7.4%, securities for 5.7%, credit cards for 3.5% and other items for 3.6%.

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