John Webster – Chief Executive of Swift Group
Any copywriter worth his salt has to come up with extreme metaphors to describe the amount of personal debt in the UK. The current favourite is ‘debt mountain’, which really gives the impression of the scale of the problem. With personal debt running at £1.5 trillion and increasing, there must be concern as to what image can take the place of mountain if we get to £2 trillion. As it’s exploding, a ‘debt volcano’ perhaps?
The very real personal debt issue is becoming a reality for more and more people as they exhaust their credit limits and find further sources of credit harder to come by. The need for advice has never been greater and it is no surprise that the majority of secured loans, including mortgages, arranged to cope with consolidation are sold by intermediaries, while the majority of unsecured loans are provided by high-street banks and building societies. According to a press release produced by Halifax earlier this year, debt consolidation is the main reason people take out an unsecured personal loan with it and it is likely this trend is true of other high-street lenders.
The intermediary role
The tricky part for intermediaries is the advice they give needs to take into account both the Financial Services Authority’s (FSA) ‘Treating Customers Fairly’ (TCF) regime and also specifically refer to the original Mortgage Code Of Business (MCOB) guidance as far as the consolidation of unsecured debt is concerned. The FSA has always maintained the consolidation of unsecured debt into a loan secured against property (usually the family home) should only be considered as a last resort.
While this might not be what intermediaries want to hear, the important point here is that brokers should run through all the alternatives to consolidation, which might include working with the client and suggesting the importance of negotiating with creditors such as loan companies, banks and credit card companies to reschedule payments in order to reduce them.
Although there is no attempt by the FSA to suggest secured consolidation is not the right course of action, clearly the adviser needs to ensure the customer has been made aware of all the options before this is considered. Once this option is introduced, mortgage intermediaries need to stress that clients think carefully before securing debts against their homes and understand the risk of having their home repossessed if the repayments on their mortgage or secured loan go into arrears.
Alternatives
The rescheduling of debt, along with a proper budget, as an exercise in belt tightening without recourse to new funding would probably be the preferred method of pure debt counsellors. The argument is that consolidation by means of another loan only perpetuates the indebtedness and leads to a repeat of the whole process of increased spending rather than living within a budget tailored to the income.
In worse situations, where the matter has degenerated too far for debt restructuring, applying for bankruptcy – and the protection that affords from creditors – can be the best route. But while the introduction of recent legislation has made bankruptcy less penal than it was, it is still not an easy option.
Debt consolidation and the circumstances under which it was accrued can vary wildly. There is a world of difference between the client living above his means, which is clearly the scenario the FSA is concerned with, and the asset rich consolidator, who is using his equity to raise finance to cover business debt, for example. One has allowed their situation to get out of control, while the other is making a planned move because it suits him. The choices open to homeowners are clearly wider than for others, opening up the opportunity to unlock equity in order to pay off debt but a look at all the alternatives open to customers would be instructive.
Unsecured loans are at the forefront of debt consolidation for people going directly to banks or other high-street lenders. With sums up to £25,000 available currently at a fixed rate of around 6.4 per cent APR for terms between two and seven years from the Halifax, it is not surprising this method is popular. On the other side of the coin, non-home owners with a poor credit record may be limited to providers whose interest rates mean that, even were they accepted, it would only be a short time before the burden of repayments overwhelms them.
Intermediaries, who see their role as providing lending solutions to clients, probably do not see themselves as debt counselors in the mould of Citizens Advice Bureau. However, when clients are at a point where the debt is too great to support from income, no matter how the solution is restructured then there is a duty to ensure that the options of debt restructuring are fully discussed and recorded.
Homeowner options
For the homeowner, the options are considerably greater. Homeowners with a mortgage can obtain a further advance from their existing lender, remortgage to a new lender while increasing their borrowing to pay off existing debt or take out a secured loan, which sits as a second charge behind the original mortgage.
The further advance is a win-win. For the existing lender it should be a relatively cost-effective transaction. For the client, it keeps the borrowing under one roof which can be convenient. On the other hand, rates for further advances might not be as attractive as the existing rate and might not be as flexible. For borrowers whose credit record has deteriorated, a further advance might not be possible or if it is, it might be at higher rates.
Remortgaging is a very popular route and a natural default for mortgage brokers, who are able to offer clients a better all-round package, which improves on the existing mortgage as well as mopping up the sums required for consolidation. When mortgage rates are reducing, this made a lot of sense as indeed it does when clients can take advantage of lower fixed and discount rates, especially if they have been used to a standard variable rate (SVR) or are coming out of an old fixed rate ‘lock in’. Again, as has been aired many times before, remortgaging might look on paper to be the most suitable way to consolidate.
But clients are sometimes unaware that while their monthly repayments might be lower, even with the added debt, the fact that they are going to repay it over a longer period of time (up to 25 years) can mean that they are paying considerably more in the long run. What is important to the regulator is that this is made clear to the borrower.
Secured loans
Secured loans have made considerable inroads over the last few years as a serious contender for those wishing to consolidate debt. They have proved to be particularly effective where clients have suffered from adverse credit on their other borrowings. For those clients who have mortgages on good prime terms, a further advance might be refused and a remortgage to consolidate their arrears would actually cost the client more on a monthly basis due to the exit fees on their existing loan and requiring non-conforming on the whole of the new account. The secured loan option in cases like this allows the consolidation to take place without removing the prime mortgage. Apart from that, many customers have a need to take action quickly and the remortgage or further advance scenario in many cases is just not quick enough for the purpose of meeting the immediate needs of clients. Secured loans with their faster processing can complete considerably faster than a traditional remortgage arrangement.
Lending industry should be proud
Consumer debt is a fact of modern life but let’s remember that it remains a key component of the extended positive economic cycle we have enjoyed over the past 10 years. However, proactive education of future generations in the management of personal finance could be a major factor in controlling the growth of personal debt in the future. The ability to be able to wipe out debt through using equity is only sustainable while property prices are stable. And for the many who do not have access to property on which to borrow to consolidate, there is the need for clearer assistance on how to manage debt through negotiating reasonable restructuring of debt payments or alternatively looking at other options such as bankruptcy or Individual Voluntary Arrangements (IVA) in the event of being unable to bear the debt burden.
Education might not be enough to make people live within their means but the need for advice on handling debt has never been greater. Consumers have never had access to such a range of consolidation options and provided lenders and intermediaries take the right steps to put the TCF protocol at the heart of their advice, then the lending industry can be proud of the service they render in this sensitive area.
