What is a Debt Consolidation Plan and How Does It Work?

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Debt consolidation plan

It’s very common to hear Singaporeans complain that they have no money. While this is often said half-jokingly, it’s true that many of us somehow manage to spend all our income within 2 weeks of getting paid. Whether it’s because of bills, household expenses, tuition fees for the kids, or shopping, our income is never enough!

That said, if we can still manage to pay off our debts or minimum outstanding dues each month, it’s not that bad. But when we can’t afford to, that begins to get really scary. We could stand to lose everything.

One of the ways to combat mounting debt is through a debt consolidation plan, or DCP for short. That’s what we’ll be talking about today.

What is a Debt Consolidation Plan (DCP)?

According to the Association of Banks in Singapore (ABS), a DCP is “a debt refinancing program which offers a customer the option to consolidate all his unsecured credit facilities across financial institutions with 1 participating financial institution”.

To put it simply, if you have to make payments on multiple loans and credit cards to various banks, you can just combine all of these payments into one single payment that you then make to a single bank or financial institution in Singapore.

The financial institution, in turn, pays your creditors.

Simple, right?

Apart from the simplicity it offers, DCPs have interest rates that are lower than the combined interest you end up paying on all of your loans and credit cards.

So, let’s assume that your credit card charges you an effective interest rate (EIR) of 25.9% p.a. and a 5-year personal line of credit has an interest rate of around 12.75% p.a. The interest rate payable on your DCP will more often than not be lower than any of these interest rates. In fact, the EIR payable on most DCPs is around 7% p.a. to 10% p.a. HL Bank’s Debt Consolidation Plan even has an EIR that starts from as low as 6.63%.

At the outset, it is important to keep in mind that debt consolidation plans only covers credit card debt and some unsecured loans such as personal loans. If you have any other loans such as a renovation loan, car loan, medical loan, home loan or an education loan, you will have to continue making payments on them without the help of a debt consolidation plan.

Read: What are Secured and Unsecured Loans?

Here’s how much you get with a DCP

The DCP amount that you are granted is the sum of your outstanding balance (including any interest or fees that have been levied) and an additional ≤5% allowance.

This allowance is to help you tide over any payments you may have to make from the time you apply for your DCP until the time it is approved. This additional allowance is compulsory if this is your first approved DCP.

You should also keep in mind, that once you apply for a DCP, you won’t be allowed to use any of your existing unsecured credit facilities.

So, does that mean you have to use cash and NETS for everything?

Not necessarily, when your application for a DCP is approved, you are also given a revolving line of credit with a limit that is 1x your monthly income. This revolving credit facility is usually in the form of a credit card.

Here’s what you should know about this revolving credit facility:

  • The fees and charges you are subject to depends on the financial institution you are banking with.
  • You cannot request a decrease in the amount you are given. You can, however, choose to not use it. You can’t cancel it either since it comes bundled with your debt consolidation plan.
  • You can’t get a temporary increase in the credit limit, but you can request for a permanent increase if your monthly income increases.

Related: 5 Ways to Save on Your Credit Card Bill

How does a Debt Consolidation Plan work?

Let’s take the fictional example of Mr Tan to better understand how debt consolidation plans work.

Now, Mr Tan earns a monthly salary of S$3,000 and owes various institutions a combined amount of S$50,000. This amount is spread between credit cards from Standard Chartered, Citi, and OCBC, and a personal loan from Bank of China (BOC).

The minimum monthly payment on the Standard Chartered credit card and Citi credit card is 1% and the minimum amount to be paid on the OCBC credit card is 3% of the overdue amount, while the minimum monthly payment on the 3-year loan from BOC is 3% of the amount payable.

Product

Outstanding Balance Interest Rate (p.a.)

Minimum Monthly Payment

Credit Card 1

S$10,500

25.9%

S$331.62

Credit Card 2

S$7,500

25.92%

S$237

Credit Card 3

S$12,000

26.9%

S$629

Personal Loan (BOC)

S$20,000

17.07%

S$884.50

Total

S$50,000

S$2,082.12

Mr Tan pays S$2,082.12 in the form of minimum monthly payments! This is 69.4% of his monthly salary! And paying only the minimum amount means that every month the outstanding balance is compounded, spiralling him into debt which will take him decades to be free of.

So, he decides that we will apply for a DCP from POSB for a period of 8 years with an EIR of 7.23% p.a. He uses a DCP repayment calculator and realises that with the DCP he only ends up paying S$995.49 per month for the same amount of debt.

This new amount is now just 33.18% of his monthly income!

Note: This example is purely for illustration purposes and actual numbers may vary as per the amount you owe and the financial institution providing the debt consolidation plan.

Check out: 8 Clever Tricks Online Shopping Websites Use to Make Us Open Our Wallets

What you need to keep in mind while applying for a DCP

If you find yourself in a situation that is eerily familiar to Mr Tan’s and are looking to apply for a DCP, keep these in mind:

  • You will be eligible for a DCP, only if your debt is 12 times greater than your monthly income. In the case of Mr Tan, his monthly income was S$3,000 while his debt was S$50,000, making his debt greater than 12 times his monthly income.
  • Approach any of the 14 participating banks and financial institutions and apply for their debt consolidation plan, or apply for a DCP through BankBazaar.sg. You don’t need to have a prior banking relationship with any participating institute.
  • You will have to continue making payments on all of your loans and credit cards while you are waiting for your application to be approved.
  • You don’t need to notify various banks that you have started a DCP. The bank with which you have a DCP will notify these financial institutions.
  • You will need to stop any GIRO payments from your account for credit card bills or unsecured loan instalments and make alternative arrangements after your DCP application is approved.
  • You cannot do a partial consolidation of your outstanding debts. Financial institutes will only approve your application if they can consolidate all your outstanding personal loan and credit card debt.
  • Should you have any unbilled transactions there were not part of the documents submitted to the bank during your DCP application, you are still liable to make payments on those credit facilities. However, once you take on a debt consolidation, those excess bills become due immediately.
  • You can once again start applying for unsecured credit facilities with any bank (other than the one providing you with the DCP) only when the ratio of your unsecured balance to your monthly income reduces to at least 8 times the income you earn each month.
  • If you want to apply for an unsecured credit facility with the same financial institution you have a DCP with, the ratio needs to reduce to at least 4 times your monthly income.
  • If you find that another bank’s DCP rates are more attractive, you can refinance your plan. This can be done only 3 months after your DCP has been approved.
  • If you decide to repay your DCP earlier than the prescribed tenure, you may have to pay an early repayment fee.

Related: Financial Issues? Here Are 6 Tips to Avoid Having Them

Debt consolidation plans and your credit report

When you take up a DCP, your credit report will be updated with the DCP product code since it is an unsecured line of credit. And like with all products, this information will remain on your report for a period of 3 years post its closure.

We wouldn’t be too concerned about its impact on your ability to take on more credit in future. Especially, if you’ve reached a stage where you need a DCP. It is more important to clear your outstanding debt in the present.

Related: 4 Credit Score Lies You Should Not Believe

Who is eligible for a DCP?

To be eligible for a debt consolidation plan, you need to be a Singapore citizen or a Permanent Resident. According to the ABS guidelines, you also need to be a salaried employee with a minimum annual income of S$20,000 and less than S$120,000. However, note that all banks in Singapore require at least S$30,000 annual income, not S$20,000.

Now that you know what a debt consolidation plan is and how it works, a mountain of debt and having more loans than you can keep a track of are a thing of the past.

Remember, that while a DCP can always bail you out of debt, the ability to control your spending is in your hands and yours alone.

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