Put very simply, debt consolidation involves taking out a loan with which to pay off all your other debts.  So, in effect, you replace mutliple regular payments with just one.  Seems easy, yes?  Perhaps debt consolidation is the best solution for your current situation but it is vital that you take many things into account before going ahead.  According to leading UK charity, Consumer Credit Counselling Service, taking out consolidation loans to pay off debts can have disastrous consequences for the over-indebted.  When you think about it, borrowing to get out of debt can’t be a good idea because you’ll just end up owing more. 

Reasons for Considering Debt Consolidation

Everybody’s circumstances are, of course, very different.  Here are some reasons why you might want to consider debt consolidation:

• You are finding it difficult to keep up to date with existing debt repayments
• You are having problems affording day-to-day expenses
• Your existing debts have high interest rates and you would like to lock your debts into one, lower rate.
• You want to reduce your regular payments to a new lower amount

Advantages and Disadvantages of Debt Consolidation

Advantages

• Debt consolidation can reduce your monthly debt repayments High interest rates are replaced with a lower rate.
• Debt consolidation will allow you to combine multiple debts into a single one
• Your creditors will go away – satisfied to have been paid
• You will have just one creditor to keep  happy

Disadvantages

• Debt consolidation payments can go on for many years
• Interest rates can be very high – you must check out the total amount you will repay over the period of the loan
• If the loan is a secured one, your house (or whatever you have used as security) will be at risk if you do not keep up the repayments
• You will be in debt for longer than if you paid off your debts individually .
• The contracts for debt consolidation loans are very prescriptive and  you will incur a financial penalty if you lengthen or shorten the period of the loan
• A secured loan will be linked to the Bank fo England interest rate – so your repayments will increase as interest rates increas.  The reverse is, of course, also true.

Debt Consolidation Regulation

Secured Loans

Companies offering secured loans that are based on releasing the equity on your home via a remortgage must be registered with the Financial Services Authority, which makes it compulsory for them to provide you with certain information.

Loans that are not mortgages are not regulated in the same way.  The loan company you use must have a Consumer Credit Licence issued by the Office of Fair Trading. This imposes certain conditions on them which require them not to mislead you.

Unsecured Loans

It is rare to be offered an unsecured loan for amounts above £25,000.  Once again, the Office of Fair Trading are responsible for regulating companies offering unsecured loans.

Choosing a Consolidation Loan

Apart from shopping around for the best terms you can find, you should take the following points into consideration:

What is an Unsecured Personal Loan?

When you take out an unsecured loan you sign a formal agreement to pay the loan back within a set period of time but you  are not required to offer any collateral – that is, if you default on the loan the lender cannot seize any of your property to help pay off  the debt. A simple example of an unsecured loan is buying something using your credit card. When you authorise payment using your card, you are entering into an agreement to pay back the money you have borrowed based on the contract you signed when you took out the card initially.

If the loan is not paid within the agreed time,  additional fees may be charged, the account may be placed in the hands of debt collectors, and legal proceedings may be instigated against you.

Advantages of Unsecured Personal Loans

• Unsecured loans can be incredibly quick to arrange – within 24 hours in some cases
• You are not at risk of losing any property if you don’t repay your debt as agreed
• No restrictions are imposed on how you spend the money
• Paying an unsecured loan responsibly can help you to repair a damaged credit rating

Disadvantages of Unsecured Personal Loans

• Interest rates are much higher than with a secured loan
• You cannot borrow as much money as with a secured loan

If in doubt, always take advice from an independent financial advisor.

A personal loan can be defined as a debt taken on by an individual.  One example is your mortgage, which is an arrangement to borrow money from a financial institution to be able to buy a home.  You then pay the money back over a defined period of time.  The lender charges you interest for the privilege of lending you the money. Interest is, basically, a percentage of the balance of the loan, which may vary based on your credit history, the amount of money you’re borrowing, the national interest rates, and the whims and terms set forth by the lender.

What is a Secured Personal Loan?

When you take out a secured personal loan you give the lender rights to property of some kind that may be seized if you stop or get behind with your payments.  This ‘seizable’ property is known as collateral.

What can be Used as Collateral?

There are a whole variety of things that may be used as collateral to secure a personal loan, including homes, vehicles or land.  Some lenders will also consider securities such as personal savings accounts, stocks, bonds or luxury items – what they are looking for is something that is worth significantly more than the amount you’re borrowing.  In the event that you don’t pay your debt, your lender will sell the collateral in order to get his money back.

Advantages of Secured Loans

• You can borrow significantly more money than you can with an unsecured loan
• Interest rates are usually much lower for secured loans than for unsecured loans
• You are more likely to get a secured loan than an unsecured loan if you have a bad credit history

Disdavantages of Secured Loans

Just the one – if you don’t keep up with the payment plans, you will lose whatever property you have put up as collateral.

A Debt Management Plan (DMP) is a way of paying off debts that have become out of control because they take up too large a proportion of your income.   They are usually arranged my a third-party organisation, who will calculate the total level of debt and set that off against the total level of income.  They will then enter into negotiations with lenders and arrange more realistic payment plans.

If a lender takes legal action against you  to recover unpaid debts and it is obvious that you cannot afford to pay, the County Court can also instigate a Debt Management Plan.  To do this, they will take into account essentials, such as mortgage, rent, utilities and transport and will make a repayment order based on the amount you have left over each month.  They will also freeze any interest so that your debts do not get even greater.

How Do I Set Up a Debt Management Plan?

The CAB and National Debtline are your first ports of call for free, impartial advice.  There are also a number of fee-paying debt-advice agencies who will not only work out what you can afford to pay and negotiate with your lenders but will also administer your reduced payments – you pay the money to them and they pass it on.  Typically you can expect to pay one of these companies around 15% of your regular payment as their fee, plus set-up fees.  However,  banks and credit card companies tend to look more favourably on applications made on your behalf by these agencies.

What are the Advantages and Disadvantages?

Making reduced payments means it will take longer for you to clear your debts, however, you won’t have to deal with your creditors – you simply refer them to your debt management agency. Remember too that there is no guarantee that your creditors will accept a reduced payment plan or freeze the interest.  Having said that, most of them do because this is their best hope of getting paid.

You should be aware that  your credit reference file will show details of the debt management plan, which could affect your ability to gain credit in the future.