When you see a TV advert or hear something on the radio that mentions the opportunity to “reduce your debt in minutes,” or “legally become debt free,” do you know what you’re actually getting into? Perhaps you’re reading this having previously signed up to such a service thinking you were getting a great deal, only to get your fingers burnt later when you realized it wasn’t such a great deal after all.
To help you avoid being fooled into a bankruptcy when you think you’re consolidating your debts, we’ve taken a look at some of the different ways you can deal with your debts here in Australia. Consider all of this information carefully if you’re looking at whether to consolidate your debts, or have been speaking with a company that promises to make you “debt free in minutes.”
What is Debt Consolidation?
The simplest way to define debt consolidation is to say:
“Debt consolidation is the act of reducing the number of creditors to whom we owe money.”
So, let’s say you owe money to five creditors. Managing five payments going out of your account each month, and having to make five phone calls each time you need to change your personal details or discuss your circumstances, can be stressful. Therefore, it makes sense to take out a personal loan, use it to repay those five creditors, and then just repay the one.
Notice that we don’t mention saving money or becoming debt free quicker. This is because, although debt consolidation can save you a significant money and help you become debt free quicker, it isn’t a guarantee, and the effectiveness of debt consolidation depends on both an individual’s current financial circumstances but also on their financial behaviour once they’ve consolidated the debts.
Fear, Uncertainty, and Doubt Used to Sign You Up
It is this element of doubt around the benefits, as well as the pros and cons, of debt consolidation, that many of the companies offering “Get Debt Free Fast” solutions tap into. When you call them they may even talk about debt consolidation loans and say things like:
What are these companies really going to do with your accounts once you’ve fallen for the sneaky tactics they’ve used to scare you into taking out their brand of “debt consolidation”? Instead of consolidating your debts, you will usually be entering into what is called a Part IX debt agreement.
What is a Part IX Debt Agreement?
This is a legally binding agreement between a debtor and their creditors. When putting a Part IX debt agreement together, creditors agree on the debtor repaying a specific amount of money over a set period of time, after which their debts are considered settled.
For example, let’s say you have debts of $40,000, and you are struggling to meet the obligations. You can look to enter a Part IX debt agreement, and you tell your creditors you can afford to repay $200 per month. Let’s say the Part IX debt agreement is then put together over five years. This means that over the next five years you would repay $12,000, with all of your current debts considered settled at this point.
No doubt you’re already thinking this sounds great, because you’ve saved at least $28,000 without even considering any additional interest you’d have accrued, and you’re now debt free.
Unfortunately, it isn’t as simple as that.
What These Companies Aren’t Telling You
The huge problem here is that you still believe you are consolidating your debts, and that somehow you’re getting your creditors to accept that they’re going to receive less money from you than they should do, but also not facing any long-term consequences yourself. Here’s what you need to know.
You Aren’t Made Bankrupt, But What You Do is an Act of Bankruptcy
While entering a Part IX debt agreement is not the same as being made bankrupt from a legal standpoint, in terms of your credit file it is considered as an act of bankruptcy. This means the effect on your credit score, your ability to attain credit, and the overall impact on your life can be broadly the same as if you were made bankrupt.
Your Creditors Vote on Whether to Accept the Agreement
Once you hand over all your account details and authorise the company who is taking care of your “debt consolidation” to speak with your creditors, you’re often told that everything is being taken care of and you’ll be notified once your creditors have accepted your proposal. To get to this stage you’ve usually signed an agreement of some type with the management company and have probably paid a few hundred dollars in what are deemed set-up and administration fees.
Your creditors then vote on whether to accept the proposed Part IX agreement.
If a majority votes “no,” you won’t get your set-up fees back from the management company, and are still left with your outstanding debt to repay, despite what you were promised.
The Full Amount You Pay Doesn’t Go to Your Creditors
Let’s say your creditors vote “yes” to accept your proposal. You might think that everything’s great, but you’re not going to be paying off your debts to the extent you perhaps think you are.
Imagine again that you can afford to pay the $200 per month we used as our example earlier. You tell the debt management company you can afford to repay this figure. However, they might end up offering your five creditors $15 per month each, while taking a management/administration fee of $125 per month for themselves.
So, instead of repaying $12,000 of the $40,000 you owe, you actually end up paying just $4,500, with the debt management company taking most of your repayment!
You Haven’t Actually Consolidated Your Debts!
We can’t stress this enough.
Throughout all of this, you haven’t actually consolidated your debts. The worst aspect of all this? You think you have successfully undergone debt consolidation, and while your management company would have advised you not to apply for credit in the coming years, you have no idea what has actually happened and what the consequences are.
Here at NOW FINANCE we’ve even had customers come to us for a personal loan and being declined because of a previous act of bankruptcy that they didn’t know about as they thought they had consolidated their debts. As well as being unable to get a personal loan with NOW FINANCE they’ll struggle to get a mortgage, car finance, and maybe even to take out a new mobile phone contract.
How to Avoid Being Caught Out
The best way to avoid being caught out by one of these companies is to avoid anything that says “Reduce your debts in minutes” or that tries to seduce you with similar messaging. If you are looking at alternative ways of managing and reducing your debt beyond a debt consolidation loan, take the time to read the contracts you are sent and know exactly what you’re getting into. Signing up to be debt free in a few years might sound like an attractive idea, but taking the short term fix now could leave you in financial ruin for many years to come, even after you are released from the debt agreement and are debt free.
If you want to consolidate your debts then a debt consolidation loan is the best and really the only option you should consider. If you are unable to be accepted for a debt consolidation loan then you should really speak to a debt counselor to explore your options and come to the best solution for you – and they’ll almost never recommend entering a Part IX debt agreement!
You can see whether you’re likely to be accepted and get your interest rate before applying for a NOW FINANCE debt consolidation loan, enabling you to work out how much you’ll repay as well as whether debt consolidation will actually work out as a cheaper, more effective way for you to become debt free quicker.
Disclaimer: This article contains general comments and recommendations only. This article has been prepared without taking account of your objectives, financial situation or needs. Before taking any action you should consider the appropriateness of the comments made in the article, having regard to your objectives, financial situation and needs. If this article relates to the acquisition, or possible acquisition, of a particular credit product you should obtain and consider the relevant disclosure documents before applying for the product.