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Debt consolidation – secured loans and other options

Almost everyone has some form of personal credit, whether that’s a credit card, a personal loan, a store card, car finance, or an overdraft. Credit can be a convenient way to make large purchases while spreading the cost into regular, manageable payments.

However, sometimes those debts can build up and you might have clients who are finding it difficult to manage. As home owners, one of the solutions available to them is taking out a secured loan.

A debt consolidation loan is not for everyone, but it’s certainly a viable and useful option for home owners. In this blog, we’ll look at some of the other options your clients have and some of the reasons why a secured loan might be the right choice.

What is debt consolidation?

First off, let’s look at what debt consolidation is. Some clients might not have considered it before, or have some misconceptions about what it actually involves.

In this instance, debt consolidation is where the client takes out a secured loan to pay off their other debts. The proceeds of the loan go to their creditors to settle what they owe, leaving them with the secured loan to pay back.

Your clients might think it’s a strange idea – taking on more debt to pay off existing debt – and it can seem counter-intuitive. But providing that it’s done the right way, it can work and can often save your clients money on a monthly basis.

The clients can pay off almost any debt with a secured loan – credit cards, personal loans, store cards, payday loans, car finance, and even other secured loans.

It’s not something that everyone should do, and there are several alternatives that you might want to discuss with the clients. But, in general, a debt consolidation loan is often the best solution available for home owners who are having problems managing their debts.

We’ll look at why this is a little later. But first, let’s look at some alternatives…

Balance transfer

If it’s credit card debt that’s causing your client problems, it might be possible for them to transfer the balance to an interest-free card, which can make the payments more manageable and give them a better chance of paying it off.

There might be a fee to transfer the balance and the client is likely to need a good credit score to qualify for the best deals.

Something to make the clients aware of is that if they miss payments, they might lose the interest-free deal, so they could find themselves back where they started. A balance transfer can work, but the client will need to commit to paying off the debt within the interest-free period to get the most benefit from it.

Personal loan

Taking out a personal loan to pay off credit card debt can be a good idea if the interest rate is lower than the rate on the credit card and your client can comfortably afford the monthly repayments.

However, some lenders will limit the term of the loan to 5 years if it’s being used for debt consolidation – as a result, the monthly repayments might only be slightly cheaper than the minimum payments already being made to credit card.

It can still be worth doing, though. If your client is only making the minimum payment to a credit card, it can take a lot longer than five years to pay it off. For example, a 18% credit card with a balance of £250 will take roughly 6 years and 9 months to pay off using minimum payments.

The good thing about using a personal loan is that, unlike a credit card, there is a clear end date to the debt. However, if your client is already struggling with minimum payments to a credit card and the cost of a personal loan is not significantly cheaper, then they could be replacing one problem with another.

Arrangement

If your client is struggling with payments, they could contact their creditors and ask to enter into an arrangement where interest and charges are suspended, monthly payments are reduced, or a payment holiday is given.

This can work if the reason your client is struggling is due to a temporary or short-term event – such as being in between jobs, or having had to cover some unexpected costs, like a major vehicle or home repair. An arrangement can give them a bit of breathing space until things get back to normal, and they are able to make regular payments again.

If the situation isn’t temporary, and your client doesn’t foresee a time in the immediate future where they’ll be able to make their regular payments again, then an arrangement might make things worse, as they’ll be keeping themselves in debt for longer.

An arrangement will also show on their credit file – this can have an impact on their access to future mortgage deals.

Debt management plan

For clients who have multiple debts, who don’t want to approach their creditors, or are finding that the debt is becoming unmanageable, then entering into a debt management plan is another option. These can be arranged by debt charities such as StepChange, or debt management companies.

Debt management plans can definitely help as they will reduce your clients payments to manageable amounts. But, because they are making reduced payments, it will take longer to pay off and complete the debt management plan. Also, like an arrangement, a debt management plan will show on your client’s credit file and their overall credit profile can be affected. Many mortgage lenders won’t offer a mortgage to a client with an active debt management plan.

For those clients who are really struggling, debt charities can also look at other solutions, such as Individual Voluntary Arrangements (IVAs) or bankruptcy.

Now, you might be reading this, thinking “I’m a mortgage adviser, I don’t have to talk about all that with my clients.”

But go and have a look at MCOB 4.7A – it clearly states that when assessing the suitability of debt consolidation you should consider “where the customer is known to have payment difficulties, whether it would be appropriate for the customer to negotiate an arrangement with his creditors rather than to take out a regulated mortgage contract.”

So, we’re not suggesting that you have to give debt management advice, or send your clients away – but where it’s relevant and clients are clearly struggling, you should discuss the alternatives.

And now we’ve looked at some of the alternatives, let’s look at the pros and cons for your clients when taking out a secured loan to consolidate debt.

The risks

The main risk of taking out a secured loan to pay off debt is that your client will often be replacing unsecured debt with a loan that is now secured on the property. This means that their home is now at risk if they don’t maintain the repayments to the new secured loan.

In taking out a secured loan, your client will be using up some of the equity in their property. This might affect the availability of certain deals when it comes to re-mortgaging in the future, as depending on how much they’ve borrowed, the value of the property at the time, and how much of the loan they’ve have paid off, their LTV ratio might be higher than before.

Depending on the term of the secured loan, your client could increase the length of time the debt is to be repaid and could end up paying back more overall.

The benefits

One of the main benefits of using a secured loan for debt consolidation is that your client’s debt to the original creditors is paid off completely. It will be marked as settled on their credit file and they can put it behind them.

The other big benefit in taking out a secured loan is that rates are generally a lot lower than most credit cards or personal loans and they can be paid back over a longer term – this means that your client’s repayments will be much more affordable.

In most cases, your client will reduce their monthly outgoings. They’ll have more money left over at the end of the month – money they can put into savings or spent on the things they might not have been able to until now. Sometimes, just knowing that there’s some money left over at the end of each month can give a client who has been struggling some much needed peace of mind.

Taking out a secured loan to pay off debts can simplify your client’s finances. They’ll have one affordable, monthly payment that’s much easier to manage than multiple payments due at different times of the month.

If you recommend a fixed product for your client, then as well as coming out of their bank account at the same time every month, the payment will be the same for a foreseeable future. This can help your client budget and keep track of their outgoings.

As we’ve mentioned above, some debt solutions can show on your client’s credit file and have a negative effect – which can impact them as a home owner, when it comes to re-mortgaging in the future. A secured loan will show on their credit file just like any other item of credit – but it won’t show that they used it to pay off debt, and as long as they maintain their repayments, it won’t have a negative effect on their credit profile.

Over to you

Tackling problem debt can often be a tricky task, and a secured loan is often one of the best solutions – it clears the debt, simplifies the client’s finances, and reduces their outgoings, all without any negative impact on their credit file.

We hope this blog has given you something to think about when discussing the different options with your clients and given you some tips on how to best explain the benefits of a debt consolidation loan.