BY MARTIN HESSE
If you have built up debt and are at the point where you have decided to – or are forced to – do something about it, there are various routes you can take, depending on the depth of your financial troubles. Obviously, the deeper those troubles, the more drastic the action will have to be.
An early intervention point might be when, while still being able to afford to service your debts, you decide you want to live a more healthy life financially and reduce your debt as much as you can. This would be akin to noticing that you have put on too much weight and you decide to reduce your weight and live more healthily by cutting out certain foods and increasing your physical exercise.
A widely recommended method at this point is the “snowball” method, whereby you target your smallest debt – typically the smaller debts have higher interest rates than the larger ones such as your vehicle and home loans. Once paid off, you use the money saved to pay off the next debt, and so on. The amount of money you have to pay off your debts “snowballs” each time you settle an account.
This article focuses on options open to you when your situation is more serious and you may be over-indebted. For one reason or another – your income may have decreased or your debt may have ballooned – you can’t afford to keep up with your debt repayments and may be in arrears with some of them. Your creditors may have instituted legal action to retrieve what you owe them.
The National Credit Act describes “over-indebtedness” as follows: “A consumer is over-indebted if the preponderance of available information at the time a determination is made indicates that the particular consumer is or will be unable to satisfy in a timely manner all the obligations under the credit agreements to which the consumer is a party, having regard to a) that consumer’s financial means, prospects and obligations; and b) probable propensity to satisfy in a timely manner all the obligations under all the credit agreements to which the consumer is a party, as indicated by the consumer’s history of debt repayment.”
A bright fluttering red flag signalling over-indebtedness is when you have resorted to taking out more debt to service existing debt.
Whatever strategy you opt for, it is essential not to take on more debt – some of them prevent you legally from doing so.
1. VOLUNTARY ARRANGEMENTS
If you are in arrears with a credit provider, the longer you put off taking corrective action, the worse the outcome will be, and the more it is likely to cost you in the long run, especially if the creditor takes legal action. Before the point at which your creditor hands you over to its lawyers, it is wise to approach the creditor, explain your difficulties, and try to negotiate a “payment holiday” or a restructuring of your loan over a longer repayment term. While you may not have the negotiating power of a debt counsellor, for example (see below), the credit provider is likely to take into account the fact that you are proactively taking steps to remedy the situation. If you have multiple creditors, this will need to be done for each of them.
Will my credit record be affected? If you have missed three or more payments on a debt and the credit provider has sent you a lawyer’s letter (a section 129 notice – see below, under “debt mediation”), this will negatively affect your credit record. If you have not yet defaulted on any repayments, your credit record will not be affected.
What costs are involved? No fees are payable on your side apart from a possible administration fee for restructuring your debt. Remember, though, that if the debt is restructured over a longer period, you will end up paying more in interest.
2. DEBT CONSOLIDATION
This involves using an existing credit facility or a new loan to consolidate all your smaller debts into a single large debt.
A popular method is to use your home loan. You will need to have built up equity in the home loan (the difference between the total loan amount and what is still owing), which you can then access, depending on the type of loan.
If you are unable or unwilling to use a home loan for this purpose, several banks offer consolidation loans, whereby the bank will repay your creditors (they need to be registered credit providers) and take on your debt in a single package.
There are multiple benefits to this strategy. The loan is likely to have a lower interest rate than your smaller debts, such as credit card debt and personal loans. And you deal with only one, instead of multiple, providers, with a related drop in administration costs and credit life premiums.
However, there are pitfalls and risks. First, you need to be aware that unless you have a good credit record and are considered a low-risk borrower, banks are unlikely to consider you for a debt consolidation loan.
The biggest risk is that you end up paying more in interest because, although interest rates on home loan or consolidation loans are lower than those on short-term credit, such as credit-card and personal loans, you have now converted short-term debt into longer-term debt – much longer in the case of a home loan.
Regional director and chief executive of Re/Max of Southern Africa, Adrian Goslett, says car loans and credit cards usually accrue interest at much higher rates than a home loan. Before using home equity to cover these debts, he recommends going through the numbers to work out whether it will put you in a better financial position or a worse one.
“Homeowners need to consider the long-term impact of this decision and do the necessary calculations before making any final decisions. The last thing a homeowner wants is to fall behind on repayments and lose their home because they have used their equity to cover other debts,” Goslett warns.
As an example, if you have a 20-year home loan of R1 million with an interest rate of 8%, with 10 years left to go, an additional R100 000 will cost R1 213 extra a month, costing you R45 460 in interest over the 10 years. However, if you take out vehicle finance for R100 000 over five years at an interest rate of 12.5%, you will pay R2 250 a month and R36 080 in total interest over the five-year term of the loan. The difference in interest paid is R9 380, or an extra 26% more.
The key to this strategy is not to reduce your total debt repayments in line with the reduced interest rate. In other words, instead of paying the minimum monthly amount, you pay the same into the consolidation loan as you were paying in total into your multiple short-term loans. In this way you shorten the loan term.
Will my credit record be affected? Not if you have not defaulted on your debts.
What costs are involved? No fees apart from a possible administration fee to the bank for consolidating your debt.
3. DEBT MEDIATION
This option is appropriate in resolving a dispute about a specific credit agreement with a specific credit provider and works best when a creditor has begun legal action against you, but the action has not yet reached the court stage. The debt-recovery process begins with a section 129 notice, which credit providers are obliged to issue you with once you are in default for at least 20 business days. If you have not responded to the credit provider within 10 business days of receiving the notice, the credit provider is at liberty to take the case to court, in which case you will be issued with a summons.
Debt mediation is alternative dispute resolution (the resolution of disputes through conciliation, mediation or arbitration instead of through court action) applied to a debt dispute whereby, through a mediator, you and your credit provider reach an agreement on how to repay your debt. This would typically involve:
• Negotiating a restructured, realistic debt repayment plan which you can afford; and
• By agreement, preventing the credit provider from obtaining a judgment against you and executing a court order to repossess your assets.
The National Debt Mediation Association (NDMA), a non-profit organisation dedicated to helping consumers with debt management and restructuring, says on its website: “The NDMA applies mediation to assist consumers and credit providers and debt collectors to resolve arrears, legal actions and other related credit disputes. Mediation … does not involve the courts but relies on parties sticking to any agreement or arrangement made.
“Once you have received a section 129 letter, you have the option to refer that specific credit agreement to a debt counsellor, alternative dispute resolution agent, consumer court or ombud with jurisdiction. The intention is that the credit provider and yourself resolve any dispute related to the agreement or agree on a plan to bring the arrears up to date.”
Credit Rehab, a debt resolution practice in the Western Cape, explains the differences between debt mediation and debt review on its website: “Debt mediation has proven to provide relief to over-indebted consumers who are only slightly indebted, effectively gaining financial control before the situation calls for the more formal process of debt review.
“One of the standout factors of debt mediation is that you do not have to be declared officially over-indebted – a prerequisite for undergoing debt review. It is important to note that when undergoing debt mediation, there is no binding legal contract in place, which comes with its own set of benefits and downfalls. Without the protection provided in a formal legal contract, consumers will not be able to avoid potential asset repossession. [However], the less formal proceedings of debt mediation can prove beneficial, as it is easy to cancel the process if your current finances take a turn for the better.”
Will my credit record be affected? Your poor repayment history will be reflected on your record, but because any legal action is prevented or halted, the record will not reflect a judgment against you.
What costs are involved? There is an application fee (non-refundable) and a mediation fee if you accept the agreement after the mediator has approached your credit provider. Expect to pay about R400 to apply and a further R4 000 to R6 000 per credit agreement, depending on the type of loan and amount owing.
4. DEBT ADMINISTRATION
Debt administration may be described as “debt counselling mild”. Like debt counselling, and unlike debt mediation, it is a legal process, which is enforceable by an order of the Magistrate’s Court. It applies to all your debts collectively, unlike debt mediation, which applies to individual credit agreements. However, there is a big catch: your total liability must not exceed R50 000. This is a small amount when one considers that vehicle loans are often in the hundreds of thousands and home loans in the millions of rands. However, it may be useful for young people who do not have vehicle or housing loans but who have run up debts on credit cards, store cards and personal loans.
Legal website Law for All explains: “You will need the assistance of a debt administrator, who will deduct your living expenses from your income, and divide the balance equally between your creditors. Only a court can make an order to place you under administration. If the court grants your application, the administrator will take over the management of your finances, and your creditors won’t be able to take legal action against you.”
Law for All says this option may not be cost-effective. “Interest rates are only reduced to 15.5%, and the repayment terms are usually extended open-endedly. Interest adds up, because creditors are only paid every three months. There is also no way of hiding it from your employer, as payments are deducted from your salary.”
Unlike debt counsellors, debt administrators aren’t legally required to register with a regulatory body, and in the past, some have been caught overcharging or not paying creditors, according to Law for All.
“Your administrator must draw up a distribution account every three months, and show what has happened with your money. The account must show how much was received, how much was deducted as fees and costs, and the amount paid over to each of your creditors. By checking statements, you can make sure you aren’t being overcharged or end up in deeper debt,” the website says.
If you decide that debt administration is not for you, you can cancel it, Law for All says. “But you will have to convince a magistrate that you have good reasons for your decision and that you will continue to pay your creditors.”
Will my credit record be affected? The administration listing will reflect on your credit record for 10 years and you may not apply for credit in this period.
What are the costs involved? Of all the options listed, this is the most expensive, relative to the amount of debt. An administrator appointed by a Magistrate’s Court to collect and distribute your payments to creditors is allowed to take up to 12.5% + VAT of the monthly payments for his/her service. Expect to pay a once-off fee of about R1 200 for the administration order. If an emoluments attachment order (whereby your repayments come directly off your salary) is granted by the court, your employer is allowed to take a 5% management fee on the monthly amount. This means more than 17.5% of your monthly repayment could be chewed up by costs.
5. DEBT COUNSELLING (DEBT REVIEW)
Debt counselling is a debt-resolution mechanism unique to South Africa that was introduced by the National Credit Act in 2007. Also known as debt review, it is in many ways the most beneficial option for consumers wanting to free themselves of unmanageable debt, because it is the most tightly regulated and weighs heavily in favour of the consumer.
On their website, East London firm Oyisa United Debt Specialists (OUDS) note that all debt counsellors are regulated by the National Credit Regulator, which also regulates the debt review process and all fees charged. “All consumer funds are paid to a regulated and approved payment distribution agency and distributed monthly to credit providers. [This option offers] legitimate legal protection for assets such as your home or car,” OUDS says.
Debt counsellors negotiate reduced instalments and interest rates with your credit providers, allowing you to settle your debts over a reasonable period. A counsellor may bring down your monthly debt repayments by as much as 30 to 50%, OUDS says. “The outcome is one affordable monthly instalment, making provision for you to cover your normal living expenses as well.”
Not everyone can enter debt counselling: you qualify for the debt review process by being declared over-indebted, according to the definition in the National Credit Act (see above).
Roodepoort-based debt-resolution company Ithuseng Credit Solutions describes debt counselling as “a formal legal process that provides for a consumer to be declared over-indebted and for the debt counsellor to negotiate a restructured payment plan and obtain a court order confirming the new repayment plan. The debt counsellor must be registered with the National Credit Regulator (NCR) and have an NCRDC number”.
Once declared over-indebted and accepted into debt counselling, the following will happen:
• You will be protected from legal action for a period of 60 days from the day of application and after the arrangement has been concluded, as long as you make payments according to the new arrangement;
• All your creditors will be prevented from communicating with you directly and must liaise with your debt counsellor;
• You will be listed at the credit bureaus as being under debt counselling;
• Once you have settled your short-term and unsecured credit agreements and cleared the arrears on your home loan, you will be issued with a clearance certificate, at which point your credit record will be updated and you will again be able to access credit.
The NCR lists additional important points to consider before choosing the debt review option:
• Couples married in community of property must apply jointly for debt counselling.
• Consumers under debt administration cannot apply for debt counselling.
• You cannot apply for, or be granted any new credit while under debt review.
In the past, the only way to exit debt review was to obtain your clearance certificate. However, the law has changed, letting you cancel the process voluntarily. However, you will have to pay the original instalments and interest rates again, there may be additional penalty fees, and if you default on your repayments, you run the risk of legal action. If the process has reached the stage where a court order has been granted, you will have to apply to the court to have it cancelled, which will entail legal fees.
Will my credit record be affected? You will be listed with all credit bureaus as being under debt review. Your debt review status will be cleared once you receive your clearance certificate.
What are the costs involved? There is an application fee of R50, and a fee of R300 if your application is rejected. The maximum allowable fee on a successful application is R6 000, which is payable at the first instalment. A monthly "after-care" fee of up to R400 a month is also payable (the debt counsellor will work these fees into the repayment plan). The legal fee for the consent order is limited to R750. Payment distribution agents are entitled to charge between R5 and R15 on each payment to each credit provider in the repayment plan. All quoted fees exclude VAT.
6. SEQUESTRATION
This is the most radical step. Sequestration offers a final way out of crushing debt: you will literally lose all your possessions, but then have the opportunity to start afresh, without owing anything.
Law for All says someone will be appointed to manage your finances and you will be forced to sell your possessions to settle your debt. “This includes your house, your car, furniture and other assets of value. Unfortunately, you cannot be sequestrated if your creditors feel that it won’t be in their best interests, so you will have to offer at least 20c-25c in the rand of what you owe.
“You will need the assistance of lawyers and advocates, which means that you will be forking out hefty legal fees. This process is long and often takes years to be finalised. What’s more, you won’t be able to take on debt for at least five years.
“On the upside, after being sequestrated, your entire salary is yours, and you won’t have to pay any portion of it to your creditors. Your employer will also not know about your debt problems,” Law for All says.
Sequestration is the process of liquidating your assets and distributing the proceeds to the creditors as equitably as possible, given that no claim will be met in full. There are two types of sequestration:
1. Voluntary sequestration, when you file for bankruptcy under the Insolvency Act. You ask the High Court to declare you legally bankrupt, accept the “diminished legal capacity” that goes with bankruptcy and invite the court to liquidate your estate.
2. Forced or compulsory sequestration, when your creditors apply to the court for your sequestration.
The court will grant a sequestration order under the following conditions:
• Your estate is genuinely insolvent;
• Liquidating your assets will benefit the creditors; and
• The value of the assets will cover the costs of sequestration.
This means the value of your assets needs to be relatively high. Someone with negligible assets will not be able to file for bankruptcy.
Once you have been declared insolvent and sequestrated, you lose control of your financial affairs until you are rehabilitated. This happens automatically after 10 years, but if your finances take a turn for the better you may apply to the court for rehabilitation before the 10 years are up. Once rehabilitated, you can start life with a clean slate, and your former creditors will have no further claims against you.
For a comprehensive article on the pros and cons of sequestration and the legal processes to follow, read “Going for broke: sequestration is a last-ditch option to becoming debt-free” by Roz Wrottesley.
Will my credit record be affected? Yes. Your sequestration status will be cleared when you become rehabilitated.
What are the costs involved? The legal costs are high – they may be in the region of R20 000 - R30 000. These costs will be deducted from the proceeds of your liquidated estate.
This article first appeared in Personal Finance magazine Vol. 90 (1st quarter 2022).