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Mortgage Guide
Debt consolidation
In short, the desire to consolidate loans is a massive and growing phenomenon. Whether it is the best way to deal with your debts is another matter.
What types of debt consolidation are there?
A variety of credit products can be used including:
- Unsecured loans, where you go to a bank or another lender and borrow a sum of money to pay off all other loans. Because the loan is unsecured, you do not risk losing your home in the event of a default.
- An advance from an existing mortgage provider secured against property, but leaving the original mortgage intact. You are simply borrowing more money form the same lender and your home is as much at risk as it was before.
- A "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). Here, the second charge lender waits in the queue in the event of a default and grabs its slice of debt after the "first charge" lender has been paid back.
- Re-mortgaging a property and borrowing more in the process. You go to a new lender and borrow more money, based on the rising equity in your house. Here, there is the potential to get a better deal at the same time.
- Transferring various credit balances to a credit card (including the use of credit card cheques to pay off non-credit card debts).
The benefits of consolidation
The potential advantages of debt consolidation over multiple credit agreements can be:
- Lower interest rates
- Lower monthly payments
- Having to deal with only one creditor
The disadvantages of consolidation
Many people don’t realise that there can be costs involved.
- The costs of settling an existing loan, such as redemption penalties, and arranging a new one (possibly including broker commission) can be significant.
- Debt consolidation loans often have lower monthly payments because the debt is spread over a longer period of time and because it may be secured on property, so lowering interest rates. But your home is at risk in the event of default – and you often pay more interest overall.
- Many loan providers tend to “piggyback” payment protection insurance (PPI) on their loans, sometimes without borrowers understanding what they are paying for. Such cover is usually far more expensive than can be obtained by shopping around. Usually, interest is added on the cost of the cover as well as the loan itself, making the entire loan much more expensive.
The OFT’s research found that most borrowers do not shop around for credit for debt consolidation, although this can save money – two thirds of borrowers who consolidated debts obtained information from only one provider before going ahead.
Moreover, many borrowers, particularly those in financial distress, are unaware of other alternatives which are open to them, such as negotiating with creditors themselves or getting help from free debt counselling services.
Most borrowers do not give enough weight to factors such as the length of the term of the loan and the total cost of repayments when deciding whether debt consolidation makes financial sense for them.
Before you take out a loan
Here are some issues you should be considering before taking out a debt consolidation loan:
- 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 – many “consolidators” don’t offer fixed rates.
- What the overall cost of the loan is, including exactly how much interest will be repaid over the full repayment period.
- What the monthly repayments are and whether they include insurance.
- Whether there are additional features which will change the rate at which the capital sum is paid back, for example non-payment.
- What happens if you want to repay or refinance early: many lenders will impose a series of redemption penalties for doing so and some are more expensive than others. In some cases, a penalty applies not only in respect of the loan itself but also of the insurance premiums that you would no longer have to pay.
- If the loan is secured on your home, what the consequences of not keeping up with payments might be and what happens if you want to move. Some lenders will insist on their loans being repaid in full before you move.
Should you take out a consolidation loan?
Borrowing more money to get out of debt is rarely a good option in and of itself. It often saddles the borrower with even greater debts, incurred when paying off previous loans.
There may be an argument in favour of some consolidation options, for example using a 0% credit card in cases where you can transfer debts without penalty.
And increasing a mortgage may be a way out for some people who feel they need a simplified long-term repayment approach. But it will almost certainly come at the cost of more interest payments.
For most debt problems, a sensible debt repayment plan, agreed with your creditors, is likely to offer a better long-term solution.
The logic of all this is that, wherever possible, you should avoid companies that offer seemingly-simple consolidation options.
Where to go for more help
There are plenty of organisations offering free advice on how to deal with debts. Here are some of them:
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The opinions expressed are those of the author and are not necessarily held by Certus Mortgage Solutions unless specifically stated. The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions.
You can obtain independent, professional advice for your own particular situation by contacting Certus Mortgage Solutions at the number below.
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