What Is Debt Consolidation?

 

The term “debt consolidation” has evolved to have several slightly different meanings.

 

The traditional definition refers to taking out a single new loan to repay a number of other debts. The new loan might be provided on a secured basis (usually secured against your home), an unsecured basis, or on an unsecured/secured basis with a guarantor.

 

In recent years borrowers have increasingly used credit card balance transfers to consolidate debt. One or more credit card balances are transferred to a new card, which is often provided with promotional benefits (like 0% interest) for a period of time.

 

Debt advisory firms also began using the term “debt consolidation” to describe the replacement of multiple unaffordable debt repayments with a single regular payment into a debt management solution.

 

The term may also refer to consolidating unaffordable debt into the hands of a bankruptcy trustee.

 

In this article we’re explaining the potential purposes, benefits, costs, and risks associated with all of these different types of debt consolidation. The article’s author holds professional qualifications in both mortgage and debt advice.

 

If you’d like personal advice about how to best consolidate your debts please contact us.

 

Secured Debt Consolidation Loans

 

This type of borrowing is used to consolidate a number of unsecured debts (like credit cards or bank loans) into a single loan repayment that’s secured against your home.

 

It could involve taking out a new larger mortgage, getting a “further advance” from your existing mortgage lender, or taking out a second charge mortgage (a “secured loan”).

 

Older borrowers may also have the option of taking out an equity release mortgage, which is also sometimes also called a lifetime mortgage. These mortgages could potentially eliminate your debt repayments altogether.

 

The usual purposes of secured consolidation borrowing are firstly to reduce your overall monthly debt repayments and secondly to reduce the interest rate(s) that you are paying.

 

Because the lender has security against your home, they may be prepared to offer a relatively large loan at a reasonable interest rate. This provides you with a good prospect of being able to affordably consolidate all of your unsecured debts.

 

This type of borrowing doesn’t negatively affect your credit rating like a debt solution.

 

While the interest rate you’re paying may reduce, the overall amount of interest you pay in the long-term could significantly increase. This is because secured loans tend to be repaid over a long period of time during which time interest rolls-up.

 

You may also be asked to pay for a loan arrangement fee (or a broker fee) and other costs like a home valuation report. These out-of-pocket expenses should be taken into account when assessing the benefit of a potential new loan.

 

Some lenders allow for these set-up costs to be included in the new consolidation loan, saving you some cash today. However, adding these costs to the loan could significantly increase the amount of interest you pay in the long-term.

 

The primary risk of a secured consolidation loan (excluding lifetime mortgages) is the increased risk to your home if your personal finances take a turn for the worse in the future. The recent Covid-19 financial crisis has served to underline that our financial security isn’t necessarily as stable as we might assume.

 

Another major risk is that you subsequently build up extra new debt. This could happen if your new loan repayment isn’t truly affordable, if your personal finances take a turn for the worse, or if you’re undisciplined with your future spending.

 

The overall level of risk is so high that the Government’s Money Advice Service recommends obtaining debt advice before you apply for a debt consolidation loan that’s secured upon your home.

 

Unsecured Debt Consolidation Loans

 

This type of borrowing is used to consolidate a number of unsecured debts into a new single unsecured loan repayment.

 

If your credit rating is good you may be able to access a low-interest loan from your own bank or another mainstream source of credit.

 

If your credit rating is imperfect you may be able to access a high-cost loan from a sub-prime lender. Firms such as 118 118 Money, Progressive Money, Everyday Loans, and Likely Loans have stepped in to this gap in the market that high street banks aren’t prepared to serve.

 

The usual purposes of this type of loan are to reduce your overall monthly debt repayments and to reduce the interest rates that you are paying.

 

This type of borrowing doesn’t negatively affect your credit rating like a debt solution.

 

With mainstream low-interest loans the overall new interest rate you’re paying may reduce, but the overall amount of interest you pay in the long-term could still increase. This is because debt consolidation loans tend to be repaid over a relatively long period of time.

 

Taking out a high-cost loan might result in a lower overall monthly debt repayment now, even if the new interest rate is higher than it was before. Your monthly repayment amount is lower because you’ll be repaying the balance (and interest) for a longer period of time.

 

The primary risk of unsecured consolidation loans is that you subsequently build up new debts. This could happen if your new loan isn’t truly affordable, if your personal finances take a turn for the worse, or if you’re undisciplined about your spending in the future.

 

Another major risk is legal recovery action in the event that you become unable to repay the loan in the future. This is a particular threat to homeowners and to those whose employment is subject to financial vetting.

 

Credit Card Balance Transfers

 

This type of borrowing is used to transfer one or more credit card balances (and potentially other types of debt) to a single new credit card.

 

The purpose should be to control overall monthly debt repayments, to reduce the interest rate(s) that you are paying, and to increase your ability to clear your credit card debt sooner.

 

Because credit card providers offer promotional deals (such as 0% balance transfers) there can be great opportunities to reduce your overall debt level quickly.

 

You may have to pay a fee to transfer balances to a new credit card. This will increase the amount you owe now and this additional borrowing could become subject to interest in the future.

 

Credit card balance transfers don’t negatively affect your credit rating like a debt solution.

 

The primary risks of credit card balance transfers are that you build up new debts afterwards or that you expensively use the new card for purchases or cash withdrawals. This could happen if your new credit card payment isn’t truly affordable, if your personal finances take a turn for the worse, or if you’re undisciplined about your spending in the future.

 

Another significant risk is that further credit card balance transfers could become unavailable to you when your current deal expires. This could leave you with a large debt a credit card that’s now carrying a much higher rate of interest.

 

Guarantor Loan Debt Consolidation

 

This type of borrowing is used to consolidate a number of unsecured debts into a new single guarantor loan repayment.

 

Guarantor loans are provided on both a secured and unsecured basis. In this section we are referring to the more common unsecured guarantor loans. The risks related to secured lending are explained above.

 

Lenders typically require a guarantor because your credit rating is imperfect, because you want to borrow a large amount of money, or because you cannot personally offer security (like a home that you own) to the lender.

 

The guarantor provides the lender with additional security in the event that you cannot or will not repay them.

 

This guarantor loan market has grown rapidly in recent years with well-known firms like Amigo, UK Credit, and George Banco advertising widely. It is also highly controversial and subject to increasing levels of customer complaints.

 

The purpose of using a guarantor loan to consolidate debt is to reduce your overall monthly debt repayments to an amount that you can afford.

 

Guarantor loans don’t negatively affect your credit rating like a debt solution.

 

Taking out a guarantor loan might result in a lower overall monthly debt repayment now, even if the new interest rate is higher than it was before. Your monthly repayment amount could be lower because you’re repaying the balance and interest for a long period of time.

 

A major risk of guarantor loans is to your personal relationship with the guarantor in the event that you become unable to make the repayments. The lender will not hesitate to demand payment from your guarantor (usually a relative or friend) if you don’t pay.

 

There is also a risk that you build up further new debts after taking out this loan. This could happen if your new loan isn’t truly affordable, if your personal finances take a turn for the worse, if you’re undisciplined about your spending in the future.

 

Another major risk is the threat of legal recovery action in the event that you become unable to repay the loan in the future. This is a particular threat to homeowners or those who have jobs that are subject to financial vetting. This risk applies to both you and to your guarantor.

 

Repayment Debt Solutions

 

The most common type of debt repayment solution in the UK is a “debt management plan”.

 

The main purpose of this debt management solution is to reduce your monthly debt repayments to an amount that you can afford.

 

It also consolidates your debt repayments into one single monthly payment to your DMP provider. The provider then issues payment to your creditors on your behalf.

 

A secondary purpose of a debt management plan is to reduce the cost of interest and other debt charges. Your creditors aren’t compelled to suspend interest and charges, but they generally will in response to fair debt management repayment offers.

 

Creditors remain entitled to use legal recovery procedures, but they generally don’t when they’re being treated fairly via a DMP.

 

Residents of Scotland have access to a different type of consolidated debt repayment plan called the Debt Arrangement Scheme (DAS). This debt management solution does guarantee that interest will stop and it does provide formal legal protection from creditors.

 

Your credit rating will be negatively affected if you use a debt management plan or DAS.

 

Debt management plans are available on a commercial (paid for) basis and also on a free-to-client basis. We (Bright Oak) are a commercial provider of debt management plans. The Debt Arrangement Scheme in Scotland is free for consumers to use because creditors bear the cost of the administrative fees.

 

Because you are unlikely to continue paying interest on your debts, these debt management repayment solutions could get you out of debt faster than an interest-bearing debt consolidation loan.

 

Restructuring Debt Solutions

 

Personal insolvency provides an opportunity to restructure your debt and ultimately to have part (or all) of it legally written-off.

 

Types of personal insolvency in the UK include:

 

• IVA (England/Wales/N Ireland)

• Bankruptcy (England/Wales/N Ireland)

• Debt Relief Order (England/Wales/N Ireland)

• Protected Trust Deed (Scotland)

• Sequestration (Scotland)

 

In all of the above insolvency processes a professional third party will take control of administering your consolidated list of creditors.

 

An insolvency practitioner operates an IVA or a Protected Trust Deed. Your debt repayments are consolidated into a single payment into your debt solution. Once you complete your agreed obligations any remaining unpaid debt gets legally written off.

 

A trustee operates a Bankruptcy (application fee £680) or a Sequestration in Scotland (usual application fee £200 or £90). If you have any surplus income, you’ll make a single consolidated monthly payment to your trustee. Certain assets might have to be sold to help repay your creditors. You’ll usually get discharged from a bankruptcy process after one year, but you may be required to make further regular payments for several more years afterwards.

 

An authorised intermediary submits your application for a Debt Relief Order which is then administered by the Official Receiver. Following a single £90 application fee you pay no further contributions towards your debts. You’re discharged and your debts get legally written-off after just one year.

 

Your credit rating will be seriously negatively affected if you use any of the above personal insolvency processes.

 

Restructuring debts by using a personal insolvency process is a serious step to take which, depending upon your personal circumstances, could expose you to a number of negative consequences.

 

Personal insolvency may however be appropriate for your needs if a debt repayment arrangement will take too long and debt consolidation borrowing is either unavailable, too expensive, or too risky.

 

How Can We Help?

 

If you’re considering debt consolidation options Bright Oak can help you in a number of ways.

 

Our debt advice process incorporates a review of your income and expenditure. This will enable you to confirm whether:

 

• A debt consolidation loan is genuinely affordable

• Further borrowing creates an unacceptable level of risk

• Debt solution alternatives could cost you less

• Debt solutions could get you out of debt faster

• An insolvency-type debt restructuring is necessary

 

We’re FCA authorised debt advisers who operate debt management plans in-house. Our trusted partners provide insolvency and debt arrangement scheme services. We’re not a lender or a loan broker.

 

We’re based near Cardiff and serve customers throughout all parts of the UK.

 

For a confidential chat with an expert debt adviser please contact us today.

 

 

Author: Andrew Graveson  – Qualified Debt Adviser & Bright Oak’s Founder

 

Page Last Updated: 24/06/2020

 

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