You opened the mail box. Before you are six unsecured loan statements from six different banks, each showing that you’ve been paying only the minimum amount and rolling over the balance on your credit cards and personal loans. You starred at remaining loan balance. It says $85,060.
You break out in cold sweat. “This can’t be true; there must be a mistake!”, you yelled, attracting stares from passerbys.
Just then, you realized that it was only a dream. Whew!
For some people, this scenario isn’t a dream. According to a 2015 Credit Bureau survey, 5% of unsecured credit borrowers (84,000 people) had unpaid balance more than 12 times their monthly income. The average borrower is (surprise!) not a low-income worker, but is tertiary-educated and drawing an above-average income.
To curb the excessive use of unsecured credit, the MAS has put in place a new rule starting in June 2015. By June 2019, those with unsecured debt of more than 12 times their monthly income for 3 consecutive months will not be able to (a) charge new purchases to or obtain credit limit increases on their existing unsecured credit facilities, (b) obtain new unsecured credit facilities from any financial institution.
What if you are trapped in a credit crunch like that described in the nightmare scenario? Imagine your monthly take-home salary is $2,500 and half of this goes to banks as minimum repayment for your six unsecured loans. Meanwhile, because of high interest rates on unsecured credit, your unpaid loan balance is growing like a hot air balloon.
On hindsight, this should never happen. But the more pressing issue now: what can you do to ease your credit woes? This is where a Debt Consolidation Plan (DCP) comes in.
What is a DCP?
A DCP is an arrangement with a bank to combine your existing unsecured debt into a single loan.
DCP was initiated by the Association of Banks in Singapore in January 2017. Currently, 14 banks offer DCP loans to overextended borrowers.
Who is Eligible for DCP Loans?
- Singaporeans and Singapore permanent residents.
- Income of between S$20,000 and S$120,000 per year, with net personal assets of less than S$2 million.
- Total unsecured debts exceeding 12 times their monthly income.
What are the benefits of Having a DCP Loan?
- Keeping Track
With one loan instead of six, keeping track of monthly repayments, loan balances, and interest costs becomes much easier.
- Lower Interest Cost
Interest rates on DCP loans are lower than those on standard unsecured credits.
- Choice of Loan Tenor
DCP loans can be repaid over a period of 1 to 10 years. You repay the bank by monthly installments.
How Much Can You Borrow under a DCP?
DCP banks can lend up to the total outstanding loan amount you owe.
But if for some reason, you cannot obtain a DCP loan large enough to clear your outstanding balances to the financial institutions you borrowed from, you will have to find your own means to meet the shortfall.
How Much Interest Can you Save under a DCP?
This depends on the type and amount of unsecured credit you are owing.
As an illustration, suppose you currently owe the following amounts to three banks:
Balance Rate (p.a.)
Credit card 1 $12,000 26%
Credit card 2 $13,000 27%
Personal loan $23,000 20%
Suppose the minimum payment for each of the above is 3% of the outstanding balance. Your total minimum payment each month is therefore 0.03 x $48,000 = $1,440.
Your total interest for one year is:
0.26 x $12,000 + 0.27 x #13,000 + 0.20 x $23,000 = $11,230. Ouch!#@*
Now, suppose you obtain a 5-year DCP loan from HSBC. Let’s say the effective interest rate (EIR) for loan is 14% (check current interest rates here). In addition, there is a 1% processing fee which is tagged onto the loan. Hence, your DCP loan amount is $48,480.
The monthly installment on $48,480 is computed in the usual way using time-value formula as follows:
PMT x PVIFA(60, r/12) = $48,480
where PMT is the monthly installment. Using a financial calculator, this amount is $$1,128.04. (Review Blog 13 for a discussion on PVIFA)
Total interest over a year is $6,336.59.
Total interest over 5 years is: $1,128.04 x 60 – $48,480 = $19.202.40 compared to $41,670 without a DCP (click here for the calculations).
As you can see, being on a DCP can give you some relief from the burden of paying off your unsecured credit. But it is not a cure. For DCP to be effective, you need to do your part. In particular, you need to:
- Spend within your means. Recommended: draw up a prudent cash budget to guide your spending.
- Pay your DCP loan installments on time and in full. If not, you are going back to square one by having to pay late fees and additional interest charges.