Debt consolidation as a means of debt management. Debt consolidation could be the way to solve your debt problems. If you are looking for a consolidation loan or have a debt or refinance problem and need some debt advice, then read our guide to debt consolidation to understand how to be better at debt management.
Who can provide debt advice if I get into financial difficulties?
If you are in financial difficulties, having built up a debt problem, perhaps by using credit cards, store cards and personal loans, and are in need of debt advice, there are a number of organizations and charities that you can turn to for guidance and help with debt management.
Before you think about taking out a debt consolidation loan you should review how you built up your debt problem, and carefully consider all the options available to you. You may, for example, be in a situation that is better addressed by approaching a debt counselling service or by getting debt advice from your existing lender(s)
Debt advice and counselling is available from several sources:
Citizens' Advice Bureaux
See phone book for local branch
www.citizensadvice.org.uk
Consumer Credit Counselling Service
0800 138 1111
www.cccs.co.uk
Community Legal Service
(England and Wales)
0845 123 2321
www.justask.org.uk
National Debtline
0808 808 4000
www.nationaldebtline.co.uk
Check out your credit rating
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What is debt consolidation?
Broadly speaking, debt consolidation is a debt management activity, where you take out a loan in order to pay off two or more existing debts. A variety of credit products can be used to consolidate debt including:
- an unsecured personal loan
- the transfer of balances to a credit card (including the use of credit card cheques to pay off non-credit card debts)
- a secured loan or second charge mortgage (a loan secured on property, from a lender other than the existing mortgage provider, that leaves the first charge mortgage in place)
- an advance from an existing mortgage provider secured against property but leaving the original mortgage intact
- a remortgage
Using a debt consolidation loan to consolidate existing debt into one loan may save on your monthly outgoings while, at the same time, offering a repayment discipline and clear end-date to your debt.
Do be advised that extending the period over which you repay your debt may mean that it will cost you more overall so make sure you read the terms and conditions carefully. You should also think carefully before taking out a secured loan, securing other debts against your home. Remember, your home may be repossessed if you do not keep up repayments on a mortgage or other debts secured on it.
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Why might I want a debt consolidation loan?
Debt consolidation loans are a method of tackling debt problems. Many borrowers can and do benefit from consolidating their debts on better interest rate terms. You may be able to consolidate debt at a significantly lower interest rate. For example, credit card debt that could be costing you 17.9% APR (MBNA Classic, Nationwide Classic and First Direct Visa among others; source: Moneyextra Credit Cards Comparison tool - 14/02/08) could be rescheduled onto a personal loan or secured loan charging little more than a third of that rate of interest with good debt management (e.g. Sterling Credit £25,000 secured loan over 15 years, 7.6% APR; MoneybackBank £10,000 unsecured loan over five years, 6.7% APR; source: Moneyextra Loans Comparison Tool - 21/02/08) .
You may also find making one payment much more convenient than managing a number of different debt payments. In the short term a debt consolidation loan may help with cash flow by reducing your monthly outgoings, but bear in mind that this borrowing may cost more in the long term if you are paying interest for a longer period.
Opting for a debt consolidation loan with lower monthly payments can make sense as long as you understand the reasons why the payments will be lower: a more competitive interest rate, but usually an extended repayment period as well. Take a hard look at your current debt including the payments and the interest rates before you decide whether this method of debt management is for you.
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What does having a secured debt consolidation loan mean?
If you want to borrow sums over £25,000, your debt consolidation loan is likely to be a secured loan structured as a second mortgage on your primary residence rather than an unsecured personal loan. Many advertisements on television make it sound like debt consolidation loans will solve all your debt problems. However, the typical advertising you may see on television or in a newspaper for a debt consolidation loan will only refer to this kind of home loan refinance secured by a second mortgage.
Quite simply a secured debt consolidation loan means you are "betting the house" that you can repay your debts. Think carefully and seek advice before securing other debts against your home, because you could be putting your home at risk of being repossessed if your financial situation worsens.
Most people looking to consolidate debt are looking to consolidate unsecured debt such as overdrafts, credit cards and existing personal loans. A second mortgage represents a secured debt. This can be of critical importance because the creditor has the right to seize the collateral, your home, if the loan cannot be repaid. This means you could lose your home even if you have managed to keep up the payments on the original mortgage.
If you are going to take out a secured debt consolidation loan you must think through the potential consequences. You should also consider insurance for your debt repayments but that does not mean that you should necessarily take out the insurance being offered by the lender, you may be able to find a cheaper policy elsewhere.
Moneyextra's own figures show the average size of secured loan being searched for in January 2008 at £29,871 to be repaid over an average of 12 years 11 months.
Think carefully before securing other debts against your home. Your home may be repossessed if you do not keep up repayments on your mortgage or other debt secured on it.
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How do I decide if debt consolidation is right for me?
You need to start by understanding how debt consolidation fits into solving your personal debt problem. The most effective way to get out of debt is through better debt management. You can start by cutting up credit cards - stop using them altogether - then pay off any creditors gradually with the most pressing debts at the top of the list. It is important to keep making regular payments to stop your existing debt problem becoming worse by defaulting. If you do plan to take out a loan to consolidate your debt, you really do still need to think seriously about cutting up your credit cards and cancelling any overdraft facilities. This rigour will help you manage your debt.
You may have more money available each month after your debt consolidation loan is arranged but you are still in just as much debt as before. Indeed your overall debt problem may be worse if you have borrowed extra money as well. Borrowing more money to get out of a debt problem is not an option to be undertaken lightly.
You may have taken out credit cards with the intention of paying off the balance each month as well. Good intentions are fine, but unexpected things happen in life. If you are taking out a debt consolidation loan you also need to make sure your debt management strategy addresses the true cause of your debt problem.
Individuals usually get into a debt problem because they are living beyond their means and supporting their spending habits with credit cards. A debt consolidation loan may appear to solve things by paying off the existing debts. Unfortunately, if bad spending habits continue, you may find in another year or two that you have run your credit cards up to the same levels or higher than they were before the debt consolidation loan.
If in doubt about the merits of debt consolidation, seek debt advice from one of the organisations and charities offering debt counselling services.
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What factors should I consider before consolidating debt?
The first and most important thing you need to think about is how much you can realistically afford by way of monthly repayment. However, in addition to working out what you can afford, any borrower considering taking out a debt consolidation loan needs to know:
- what the alternatives are. These can include re-negotiating existing payments on your debts with individual creditors
- what the interest rate and APR is and whether it is variable
- what the overall cost of the loan is
- what the monthly repayments are
- whether there are additional features which will change the rate at which the capital sum is paid back
- what will happen if you miss a payment
- what happens if you want to repay or refinance early
- if the loan is secured on your home, what the consequences are of not keeping up with payments and what happens if you want to move
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Should I seek debt advice from a specialist in debt consolidation?
You should be wary of many firms that do nothing else but debt consolidation. They may charge high interest rates and require extra fees on top. They may claim to offer services that would reinstate your credit or rebuild your credit history. Nobody other than you can do this for yourself if you have had debt problems. Equally, nobody can wave a magic wand and improve your credit record overnight. It takes time.
Don't pay large fees to companies that claim to be able to remove information from your credit file. Don't be fooled, they can't. Only genuinely incorrect information may be removed and you can do this yourself. County Court Judgements and other information will stay on your file for six years, although they may be cancelled if the sum owing is paid within a month of the judgement.
Many companies advertising special debt consolidation loans for "restructuring" your problem debt may also offer to lend you an extra amount on top of your current debts, so you have a lump sum with which you could buy a car, or improve your home. This is not generosity on their part: the more they lend you, the more you have to pay back, and the more money they make. You should think very carefully indeed and seek debt advice before securing more debts on your home.
An investigation by the Office of Fair Trading between June 2003 and March 2004 suggested that many borrowers failed to shop around for credit for debt consolidation and that some lenders were guilty of exploiting borrowers lack of financial knowledge and debt management skills. The study also found evidence that lenders may be "inappropriately" selling expensive payment protection insurance to borrowers.
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26 February 2008 © Moneyextra.com
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