Debt Consolidation

Some consumers turn to debt consolidation when they realise their financial situation could look better. Rather than to struggle with too many bills, and only being able to make the minimum payments on these accounts, they consolidate the debt with one institution. These consumers make one monthly payment over a specified period to pay off the debt. This could help them improve both their cash flow and their credit profile should they keep up with this plan.

Debt consolidation’s main benefit is that it is most often a single loan, so consumers do not need to make separate payments to various lenders each month. Another reason why so many people decide to consolidate is that they may receive a better interest rate with the new lender.

These loans are often secured, though there do exist unsecured debt consolidation loans. Consumers often secure the loan to their property, which offers them reduced interest rates. They decide whether they want to pay off all their debt or only a portion of it. Typical uses for debt consolidation loans are paying off credit cards and store cards; clearing overdrafts and bank loans; and using the money to finish off hire purchase agreements.

Who considers Debt Consolidation?

The average Debt Consolidation consumer is a young person who is in full-time employment. This person may be struggling with debts, or may be financially mature to realise what savings debt consolidating can bring. Various studies have been done by OFT and they found that individuals who apply for a secured loan provide Debt Consolidation as their main reason for doing so.

Advantages to Debt Consolidation

• Lower interest rates on secured loans
• Lower monthly payments
• It is a single loan and there is only one creditor

Disadvantages to Debt Consolidation

• Early settlement charges on existing loans when taking out a consolidation loan
• Broker fees and commissions
• Overall borrowing is higher because loan is spread over a longer period

Debt Consolidation versus Debt Management

What is the difference between these? Debt consolidation is opening up a new line of credit, albeit with a lower rate of interest than before. A debt management plan, however, means we negotiate with your creditors for a lower payment and interest rate.

A typical debt management plan would start with negotiating for lower monthly payments by considering what you can afford. Other ways would include asking them to freeze or lower interest rates and not to add more charges to your account.

The debt management company would do all the work on your behalf and distribute your payments to the various creditors.

A drawback to debt management plans is that not all creditors would agree to one. Some companies might still penalise you because you are defaulting on the original payment plan.

Debt consolidation options

What other options are there besides consolidation loans?

Individual Voluntary Arrangements – A legal agreement between a creditor and a debtor to repay the debt and avoid bankruptcy.

Remortgages – Switching to a new lender may result in a lower interest rate and consumers use the equity to pay off existing debt. Such loans are normally payable over 25 years, so consumers should always consider what effect this will have on their finances.

Debt Management Plans – These plans negotiate a longer repayment period, and debtors only make one monthly payment to the Debt Management Company.

Bankruptcy – Bankruptcy frees consumers from debts they cannot afford. Assets are sold off to pay creditors. This option, however, should always be a consumer’s last resort.

Other important things to consider

Do some careful thinking before taking out any type of debt consolidation offer. What is the best option for your situation? Would it be best to apply for a debt management plan, or would a remortgage loan suit you better?

The Annual Percentage Rate (APR) should be your guide when deciding which option is best. The APR is the standard measure for the cost of a loan, and is the gross amount of compound interest charged if you do not make payments. This, together with other factors such as the duration of the loan, the monthly payment and the loan amount, will affect the total cost.

Factor in what might happen if you miss a monthly payment. What are the consequences? If you feel there is a possibility you might repay the loan earlier than thought, you should find out what charges will apply.