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Industry in depth
Debt consolidation
2 June 2007
With personal indebtedness reaching record levels and bankruptcy and IVAs on the increase – how can debt consolidation help consumers, asks Jeremy Russ
“Pensioner runs up £30,000 debt” “I’m £80,000 in debt on 12 credit cards” These are just some of the shocking headlines that we see in the national press every day. However, is the problem actually this severe or is it all just PR spin?
Well, the figures speak for themselves. According to consumer research at Beacon Homeloans, 30 per cent of people admit to experiencing some credit difficulties. In addition, in Financial Services Authority research conducted in 2006, revealed that almost one in five consumers (17 per cent) believed that ‘finance was best left to the experts’. And these figures are just the tip of the iceberg.
According to the Consumer Credit Counselling Service, over-indebtedness is rising fastest amongst older consumers. The findings showed that those most likely to be in debt were between the ages of 40 and 59. Not only did this group have the highest levels of debt – with an average of £34,456 – but was also growing at a faster rate than any other group. In comparison, younger age groups, namely those between 18 and 24 owed an average of £15,079 – half the amount owed by the over 60s, which stood at £33,568 in 2005.
In addition, Bank of England figures show that mortgage debt stood at a record £1.08 billion at the end of 2006, with consumer credit (cards, loans, overdrafts, and other non mortgage debt) totalling a further £213 billion. Indeed, the debt problem is so bad that it is estimated by some pundits that over one million county court judgements are issued every year.
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So, how have so many people got into debt? The answer is not as simple as it first appears. One of the main reasons is that they simply do not have enough money to live on, so they have to borrow to meet basic needs. Another major cause of debt is that circumstances change. Redundancies happen, people lose their jobs or their overtime, they suffer bereavements and relationships fall apart. Many people simply borrow too much and become involved in more debt to make ends meet. All of these factors affect the way people are able to cope with their finances – which in many cases then leads to debt problems.
But are there any solutions or are thousands of people fated to be stuck wallowing in a mire of debt? Well, one way in which people can ‘turn their financial problems around’ is to consult an intermediary. By consulting this type of financial expert, they are likely to find that a world of possibilities exists. Perhaps they can make new arrangements with their existing lenders, use overdrafts, loans, extend their mortgage or consolidate their existing debt into one loan.
Debt consolidation is likely to play a huge part in getting many people back on the path to ‘financial health’. As you may know, this is the replacement of multiple loans with a single loan, often with a lower monthly payment and maybe a longer repayment period. This allows the consumer to regain control of their finances, as they have only one monthly payment. This payment is generally lower than their previous rate, and means they have to deal with only one lender – helping to avoid falling behind on payments and therefore, getting a worse credit rating.
However, advisers should also warn consumers that they could end up paying more overall, as the payments are set up over a longer period and there are often extra charges for setting up and repaying the new loan. If the loans that are being consolidated had interest added at the start, consumers will also be paying interest on that interest – as well as on the amount borrowed. Therefore, if they get into difficulties, it may be harder to come to a new arrangement with a single lender. Also, if the loan is secured against their home, their property will be at risk if they can’t keep up repayments.
If the debtor is an existing property owner, they have the added option of remortgaging to take advantage of the equity within their property to pay off some of their debts. While this might seem like an ideal solution to the problem of over indebtedness, it comes with the possibility of a consumer slipping into negative equity if the housing market does fall. In addition, the US mortgage market has shown that some consumers use this ‘get out of jail’ card numerous times and end up in debt well into retirement. Therefore, this move needs to be considered carefully by the consumer and guided by the intermediary.
Consumers’ taking out unsuitable products or not getting access to the correct financial advice is a huge cause for concern surrounding the current debt problems. For this reason, Treating Customers Fairly (TCF) is something that must be foremost in lenders and brokers minds when discussing debt consolidation. Pre-sale, exact, complete information must be provided and must be used to provide a concise and clear description of the product allowance. Advisers must assess the financial situation of the borrower based on their ability to repay their debt, i.e. more focus must be on their income and credit commitments rather than just their payment history.
TCF post-sale must also be taken into consideration, by putting in place systems to limit automatic, unsolicited credit, for example, limit increases and credit card cheques. Where borrowers are in difficulty, advisers must seek a genuine solution where possible and take proportionate and reasonable measures to help, for example, reschedule payments where feasible and co-operate with money advisers.
So with good financial advice it is possible for people to stay on the property ladder. But what about people who have yet to purchase their first home or need to remortgage? Well, there is hope.
Although most mortgage lenders are wary of people with adverse credit, there is a swiftly growing ‘non-conforming’ mortgage market to cater for people with these needs. These lenders are more than equipped to deal with consumers who have everything from unpaid bills to County Court Judgements (CCJs) to bankruptcies.
There are – of course – some caveats that come with these products and the interest rates are typically higher than standard mortgage products. There may also be some restrictions as to when customers can refinance or repay the mortgage but generally these consumers feel it is a small price to pay in order to obtain financing. Many brokers are able to help consumers access these products although there are some tied advisers who tend to steer clear of providing guidance on adverse credit mortgages.
In addition to this another boon for ‘credit impaired’ consumers is the move by some lenders towards affordability lending. By using an affordability-lending model, which assesses an applicant’s expected net income, living costs, and existing loans, lenders can determine an affordable mortgage repayment amount and thus loan for each consumer. This can help assist more customers in a more balanced and appropriate manner.
So there is hope and there are some good moves by the industry to help tackle the debt crisis and assist those looking for debt consolidation. But can more be done? Definitely.
We need more financial education for all UK consumers and there needs to be an increase on full information sharing between all financial institutions.
In addition, clear credit to income ratios could be set for maximum credit limits, as well as agreed triggers for industry funded independent debt counselling and such systems must operate across all lenders.
So with some hard work and the industry working as one, there is hope that in future the tabloid headlines might be more spin than fact! An odd ambition but definitely something to aspire to.
Lousie Cuming, moneysupermarket.com
The total UK personal debt stood at £1,318 billion at the end of March, with an estimate this grows by £1 million every four minutes. Running parallel with this increase is a growing trend of borrowers failing to meet repayments. The number of UK personal insolvencies continues to increase. The total of 107,288 Individual Voluntary Arrangements last year was almost a 60 per cent increase on the previous year, and the number of County Court Judgements jumped by 33 per cent over the same period.
An increasing number of homeowners are looking to ease monthly repayments and are being seduced by the promise that debt consolidation allows greater borrowing at a decreased monthly cost.
Much criticism has been levelled at the financial industry for making borrowing too easy, but the agreement to lend and borrow is a joint contract. Agreed, there must be responsible lending but just as important is the need for the consumer to borrow responsibly.
This is especially true for debt consolidation. In many circumstances, this will ease financial pressure by reducing monthly payments significantly. However, lenders need to ensure borrowers understand the reality of replacing short-term unsecured debt with long-term secured lending. Equally borrowers need to ensure 'wrapping up' their debt and releasing more disposable income does not tempt them into starting the unsecured borrowing spiral again.
This is where financial advisors add essential value to the process. They act as an invaluable bridge between lender and borrower as they understand the client's circumstances and consider the options available before making a recommendation and explaining the risks.
With an increasing sophistication of secured products available, making the right recommendation is key, and both remortgage and secured-loan options should be considered.
Increasingly borrowers are tied to their existing mortgage lender by a substantial Early Repayment Charge, but many do not have the luxury of being able to wait to the end of the term. It is rarely financially sound to take an ERC 'hit'; it makes sense to consider a second charge secured loan instead. Additionally, changed financial circumstances or the amount of available equity may rule out a remortgage, but a second charge loan may still be available for a consolidation solution.
If a remortgage is a more suitable option, many lenders offer flexible products that allow borrowers to overpay. It is not necessary to consolidate the unsecured lending over the total term. Advisors can be creative, even recommending an interest-only payment structure initially to help a borrower back into financial viability and then suggesting overpayments as soon as possible to start reducing the debt.
Consolidating debt may be the difference between a borrower being able to afford repayments or not and this has to be a positive outcome. The important issue is that the most appropriate method is chosen and all risks are explained. That is where responsible advisors fit in.
By Steve Walker, Managing Director, Promise Finance
Historically consolidation loans have been a popular solution, especially for homeowners. With the relaxation of mortgage criteria over recent years, mortgages have also come into the running and, more latterly, debt management and IVAs are proving to be a sensible solution for some.
But, in a fragmented market, historically it has been difficult for consumers, or advisors, to identify a suitable solution and a ‘one stop shop’ has not been available. However, with FSA regulated brokers now moving into the debt management and IVA arena, together with technology to support the proposition, those in difficulty can now expect to be offered a range of ethical solutions and to be treated fairly.
Customers can now expect to see many more doors open to them as a result of one enquiry or phone call. Amongst the options available, there is a consolidation remortgage or further advance. Whilst this is an attractive option, it can often be over a longer term than the prospective borrower may desire.
Sitting alongside the remortgage option, a secured loan is a flexible and increasingly attractive option, especially on loans less than £25k where the upfront costs in arranging it are low, the ERCs are subject to regulation and are also low, and the lenders’ criteria is more accommodating for those whose finances are stretched. Furthermore, those borrowers who already have an existing mortgage at a competitive rate, could be penalised by opting for the remortgage route as their status may dictate a higher overall lending rate.
For intermediaries, provided they choose the right secured loan specialist partner, the process can be very fast, the work on their part minimal and the remuneration very good by comparison to a remortgage. As homeowners fall towards the bottom of the secured loan filter they may find that, due to their circumstances, they can only arrange a loan at a significantly higher interest rate. Acceptance rates can also be quite low resulting in borrowers needing to be touted around a number of lenders, each of which will potentially undertake a credit search.
However, debt management and secured loans can work particularly effectively together in negotiating full and final settlements with the borrower’s creditors. Within our organisation we arrange debt management, secured loans and mortgages in-house and often find we cannot raise enough capital to clear all of our customer’s unsecured debts. However, following negotiations with all creditors, we’ve seen numerous occasions where lenders have accepted reduced settlements and written off over £20,000 of debt.
The combination of debt management, secured loans/mortgages and full and final negotiations with lenders under one roof, means borrowers can often avoid an IVA and settle significant amounts of debt replacing is with a secured loan/mortgage of a much lower amount. Ultimately, borrowers in debt can also consider IVAs or bankruptcy and again dealing with a company that can handle everything in-house allows consumers to look at all of the options rather than being forced down one route. For intermediaries, they can now pass their clients with serious debt, into safe hands and receive an introductory commission from the eventual outcome.
Iain Williamson, head of key accounts, BM solutions
n the first quarter of this year 30 000 people hit the insolvency buffers, either declaring themselves bankrupt or taking out an individual voluntary arrangement (IVA).
To put this into perspective, there were 24 5000 insolvencies in 1998, of which 5000 were IVAs. By 2004 insolvencies had gone up to 46 650, and by last year they had doubled again, reaching 107 000. If things continue as they have done in the first quarter of this year, then we are set to see somewhere in the region of 120 000 people get into difficulty this year. Despite this, however, arrears figures remain historically low and are currently at expected levels.
The UK’s growing debt culture is not a new phenomenon and while interest rates were falling and house prices were rising, it was easy for borrowers to take a chunk of equity out of their property, refinance their debt and be no worse off than when they started.
This is no longer the case as interest rates have hit the bottom of the cycle and begun to rise again. They may be still historically low, but the rises over the past year have quickly taken the financial slack out of many borrowers’ budgets.
These same borrowers also have little equity left in their properties and even if they were to release more, the cost of doing so would only tighten their budget further.
In the short term, borrowers need to take stock of their financial situation, and examine exactly what has brought them to their current standing. Thereafter careful cost cutting and budgeting should be the priority to ensure they can sustain their position and begin to look at improving it.
Debt consolidation is key to this and borrowers should be looking to minimise what they pay on any of their outstanding debt and put a repayment plan in place they can work to on a monthly basis.
For borrowers who are not homeowners, carrying debt has simply made it more difficult to get on the property ladder. However there are steps that borrowers can take to make this possible. Individuals should start by getting hold of their credit report so they can see the same picture that potential mortgage lenders have of them.
A move to affordability calculations by mortgage providers and the evolution of the sub prime market has made it possible for borrowers and debtors to successfully apply for a mortgage. However it is important that a mortgage does not become an albatross around clients’ necks and see them propelled into the fast growing pool of insolvents.
To this end, lenders have to be realistic with their criteria, and borrowers should understand that getting a mortgage in the short term may not be something that they are ready to deal with. Before taking such a step borrowers must have steadied their own financial ship so they are then ready to meet the commitment of a mortgage month in and month out for the years to come.
Increasing indebtedness is a problem for the UK, but it is also manageable and the closer borrowers and lenders can work together, the easier it will be to find sustainable solutions for the future.