Once your financial situation begins to worsen it can be tempting to bury your head in the sand and hope it will go away. This can lead to not only greater financial distress but also mental pressure which can often take its toll.
While not necessarily a situation you can control immediately, it is very important to take a degree of control so that you are able to make decisions on your own.
This will reduce the mental pressure and you may also be able to avert a full-blown financial crisis with something as simple as a debt consolidation loan.
For many people, the main challenge is admitting they have financial troubles – which they need to do before they can even start to address them.
Clarify Your Income, Expenses and Any Surplus
While there is often a temptation to dive in headfirst and organise a debt consolidation loan, the first thing to do is clarify your income, expenses and any surplus.
You need to be honest and realistic which will mean taking into account various issues such as:-
- What is your total household income
- What are your total household expenses
- What are your total debts
- What are your most expensive debts
- Are there any areas in which you could save money
- Do you have any assets you could use
- Do you have any savings you could put towards debt repayments
- Is there scope to increase your employment income
- What is a realistic monthly surplus (if any)
- What are your current debt repayments
- Is your credit report correct
The chances are you will know most of this information “in your head” but it is very important to get this down on paper. If you are in a challenging financial situation then the likelihood is you will need some kind of professional advice to address this.
As a consequence, any adviser will need to see details of your income and expenditure and any potential or real surplus.
The following table illustrates the top five UK cities going into 2020 with the most credit card debt per person:-
|City||Average Credit Card Debt Per Person|
The Idea Behind Debt Consolidation
The idea behind debt consolidation is fairly simple in theory but not always as simple in practice. It involves taking out one large loan which would be used to repay a variety of outstanding loans.
At first glance this may simply seem like “shuffling the deck chairs before the Titanic sinks” but there are some huge benefits.
Reduction in Debt Interest Rate
The degree to which you can arrange a reduction in overall interest on your debt will depend how far down the line you are with regards to debt repayment problems. If you have spotted potential issues at an early stage then you may well have been able to avoid any missed repayments – which would ultimately impact your credit rating and ability to raise debt.
When you consider many people will include high-interest debt such as credit cards, overdrafts and other similar finance tools in their debt consolidation plan, there is the potential to significantly reduced interest paid.
You will find that some lenders offer lower interest rates the more you borrow although this would obviously be conditional upon your ability to pay and your financial circumstances at the time.
So, in one foul swoop, you may be able to reduce your average debt interest rate down to single digits. A potentially significant development if you have large accumulated debts!
Term of Loan
When looking to repay debt the immediate reaction of many people is to repay all outstanding debt as soon as possible. This can lead to unrealistic goals and potentially greater financial problems further down the line.
Let’s say for example you were to organise a debt consolidation loan over a relatively short period, say five years, this may seriously stretch your finances. Indeed your plans could be blown off course if you encounter unforeseen financial hits further down the line.
So, what if you were to extend the debt consolidation loan to say 10 years, reduce your monthly payments, take some pressure off your short-term finances and give yourself a realistic goal?
Yes, we appreciate you would pay more in interest charges but any lender considering a debt consolidation loan would appreciate your honesty and realistic take on the situation.
If you are too “ambitious” with regards to your debt repayment timetable you may be refused a debt consolidation loan.
Can I Get a Loan to Pay Off Debt?
The simple answer is this will depend upon your financial situation and your ability to pay. Many people automatically assume that no matter how dire their short to medium-term financial situation may look, there will always be somebody willing to offer a debt consolidation loan.
This is not generally the case because there are risk/reward ratios to consider even for those operating at the perceived riskier end of the market.
There are numerous factors for debt consolidation loan companies to consider such as:-
It is unfortunate but age will come into account when looking to secure debt consolidation loans. In theory, the earlier you address your issues the more chance of securing finance but there needs to be a realistic hope of repaying a debt consolidation loan in full.
As we have affordability calculations with regards to mortgages for example, it is exactly the same for any type of loan and especially consolidation loans.
Again, there needs to be a clearly visible path to repayment with a little “headroom” between overall living expenses (including debt repayments) and income. This ensures that any short sharp shocks received in the future wouldn’t necessarily blow the recovery process off course.
If you are on the verge of serious financial issues then it makes perfect sense to take into account not only all of your debts but also all of your assets. There may be scenarios where it is possible to separate assets and finance debt repayments going forward.
Alternatively, many of those in financial distress may be advised to liquidate assets to at least pay off some of their debt. This could, in theory, be the difference between a successful debt consolidation loan application and refusal. In these situations, there can be very fine margins between success and failure.
There are two main types of debt; those secured against an asset in the event of default and unsecured loans. As we touched on above, some of those struggling with financial difficulties may be advised to dispose of their assets to part pay down outstanding debts.
However, it may be possible to use existing assets (such as a home) as security on a debt consolidation loan. There will always need to be the correct level of affordability but so long as you maintain repayments you would retain your home.
The alternative would be an unsecured debt consolidation loan which is probably the only option for the vast majority of those in financial trouble. This means that the debt is not secured against any collateral/assets and would generally attract a higher interest rate compared to a secured loan.
There may also be stricter criteria with regards to age, occupation, income and the ultimate affordability test.
Different Types of Debt Consolidation Loans
While the principle is the same, the opportunity to consolidate all debts into one loan, there are a number of different ways in which you can do this. There will always be an affordability factor in the background to be taken into account – no matter which option you choose.
However, in theory the main options are as follows:-
Vanilla Debt Consolidation Loan
This is the more straightforward type of debt consolidation loan, unsecured finance which would allow you to consolidate all your debts into one payment.
There may be significant savings to be made with regards interest charges as well as the ability to reset the loan term and monthly repayments to a level which is affordable.
As we touched on above, it is very important to be realistic with regards to your ability to pay going forward and not to be overoptimistic. If you put yourself in the shoes of the lender, somebody who is overoptimistic about their financial prospects might not in theory make the most secure of clients?
The exact level of interest and the potential term of any debt consolidation arrangement will be wholly dependent upon individual circumstances. While the industry itself is flexible, when it comes to those struggling with debt repayments there are only so many risks a lender is willing to take.
Guaranteed Debt Consolidation Loans
As we have mentioned on numerous occasions, the basics are the same whether you are lending to a high-grade customer or somebody who is struggling with their financial repayments, the risk/reward ratio.
Therefore, if the underlying customer was in serious financial trouble and there was an element of doubt as to whether they would be able to honour future repayments, a guarantor would make a huge difference.
This effectively means that if they were to default then the lender would simply revert back to the guarantor who would be responsible for either continued debt repayments or repayment in full.
There are obviously various aspects of the guarantor’s financial strength to take into consideration before agreeing to provide a debt consolidation loan.
These will include:-
- Financial strength
- Personal circumstances including age, income, assets
- Ability to pay
- Potential collateral against loan
In effect, the guarantor is being treated as if they were the underlying customer in a worst-case scenario. As we touched on above, in the event that the original borrower was to default on their repayments the lender would turn their immediate attention to the guarantor.
However, this would not necessarily mean the liquidation of collateral/assets as the preferred option would be a continuation of the loan repayments.
This way, if the underlying customer was to “get back on their feet” in the future then they would be able to revert back to covering loan repayments as originally agreed.
It goes without saying but those who are considering becoming a guarantor for somebody who has financial troubles are potentially signing up to a huge undertaking.
We have seen situations where friends and family have stepped in to help someone in financial trouble only for them to default on payments leaving the guarantor to carry the can.
As you can imagine, this can have potentially explosive consequences for friendships.
There is an old term, never mix business and pleasure….
Debt Consolidation Mortgage
The idea of a debt consolidation mortgage may seem a little alien to some people. Surely if the individual has an asset they can sell then this could/should be liquidated to cover their outstanding financial liabilities?
Well, there is a very interesting alternative which can work out for all parties in the form of a debt consolidation mortgage. What is this and how might this help all parties?
In a perfect scenario, individuals experiencing repayment problems would have a significant degree of equity in their home and the potential to remortgage.
There are a number of benefits this may bring:-
Consolidating All Debts
The idea is simple, the equity from the property would be used to pay off various loans and bring all debts under one roof. The fact that mortgages tend to be more long-term than say personal loans or other short-term financial arrangements, means that a remortgage repayment should be less than current accumulated loan repayments.
Reduced Interest Rate
This can be a bone of contention because if an individual’s financial difficulties have resulted in missed repayments then this will impact their credit rating.
In a best case scenario, they would likely to be forced to pay a higher than average mortgage rate because of their financial difficulties. In a worst-case scenario they would be refused a remortgage because of their perceived inability to keep up with loan repayments.
Retention of Property
While any remortgage application would be considered in light of affordability calculations and various other factors, the main benefit would be the individual retaining their home.
On a long-term basis, this may allow other options such as downsizing if their financial difficulties were to continue, or they may even benefit from additional capital growth in the value of their home.
Also, people tend to be more focused on maintaining repayment schedules if their home is at risk.
Can I Write Off Debt?
The ultimate goal of any debt management action is to put the individual on a more sound financial footing going forward. In some circumstances this may lead to part, or even all, of their debt being written off although this aspect would be considered on a case-by-case basis.
We will now take a look at some of the alternatives to a debt consolidation loans and the conditions which would need to be met for consideration.
Debt Management Plan (DMP)
A debt management plan is similar in principle to a debt consolidation loan although it is a more formal arrangement with your creditors.
The basic principles of a debt management plan are as follows:-
Repayment of Debts at an Affordable Rate
These arrangements tend to be managed by a DMP provider who will help you to reschedule your debts so that repayments can be made at an affordable rate.
This will be done in accordance with your creditors who would need to agree to such an arrangement.
One Monthly Payment
Rather than undertaking numerous debt repayments every month, under a DMP you would only be obliged to make one pre-agreed payment which would then be shared out on a pro rata basis amongst your creditors.
A DMP would only really be suitable for unsecured debts because there would be no financial sense in a creditor signing up if they already had security against their debt.
As a consequence, a traditional DMP would include debts such as credit cards, store cards, overdrafts and unsecured personal loans.
In some circumstances your creditors may agree to writing off an element (or possibly all) of your debt if it was obvious that pursuing repayment would be a fruitless task. While little consolation for your creditors, they may be able to offset bad debts against their taxes going forward.
In reality, there is an ongoing cost in chasing bad debts and if it is unlikely any will be recovered then from a financial point of view it makes sense to consider writing them off.
Debt Relief Order (DRO)
What may seem like a relatively large debt to others may pale into relative insignificance when considered against the individual’s income and assets. On the flip side of the coin, a relatively small debt may prove extremely difficult to pay back if the individual earns limited income.
This is one of the main reasons why the authorities introduced DROs which are targeted at those with low income, very few assets and debt which they are struggling to finance.
The idea behind a DRO is simple; the individual’s debts will be frozen for a year with no additional interest or charges added. Creditors will also be barred from contacting them directly to discuss repayment of their debts.
If after 12 months the individual’s finances have not improved, and there is little likelihood of an improvement in the short to medium-term, then all outstanding debts within the DRO would be written off.
As with a number of debt management arrangements, it is not inconceivable that some creditors may not agree to a DRO and will instead look to pursue repayment of debts owed in their own right.
However, as this type of arrangement is focused on those with limited income and limited means of repayment, the vast majority of creditors are likely to sign up to a DRO.
Individual Voluntary Arrangement (IVA)
An IVA is a more formal arrangement between an individual and their creditors which is administered by an insolvency practitioner. IVAs tend to last between five and six years during which time the individual will be asked to pay what they can afford towards their outstanding debts.
As soon as an IVA is agreed, with at least 75% of creditors in terms of overall debt voting in favour, all interest and charges would be frozen.
If there is an improvement in the individual’s financial situation during the tenure of the IVA then they may be asked to contribute more towards their debts. Otherwise, assuming that all agreed payments had been made during the IVA then all outstanding debts at the conclusion would be written off.
In the event that an individual is unable or unwilling to abide by the rescheduled debt repayments there is every chance that the IVA would be terminated and alternative debt recovery arrangements put in place by creditors.
The idea behind an IVA is simple, allow the individual to pay off as much debt as they can afford over a 5 to 6 year period and then write off any outstanding debts so they can effectively “start again”.
However, as with any debt management arrangement, there will be a note on their credit file which will remain live for six years.
While bankruptcy is often seen as the “nuclear option”, for many individuals suffering financial distress it may be the only option. While there will be credit restrictions for some years to come, bankruptcy is a means by which all debts are written off but only after taking account of income and any assets the individual may have.
Like many elements of debt management, there are a number of misunderstandings with regards to bankruptcy.
It is not in the best interest of creditors/insolvency practitioners to leave an individual with nothing. Indeed, if you owned a relatively inexpensive vehicle which was important for work you may well be allowed to keep this.
Bankruptcy does not stop you from working but if you had any surplus income this could be claimed by the insolvency practitioner and paid towards your outstanding debts.
However, the idea that creditors/insolvency practitioners would leave you with nothing after bankruptcy is wrong.
Offer in Full or Final Settlement
There may be cases where you are struggling to maintain your debt repayments but may be in receipt of an unexpected lump-sum payment. If this is the case, you can approach your creditors to discuss what is known as an “offer in full or final settlement”.
This effectively means that you are willing to hand over the lump-sum payment, which is less than your overall debt, on condition that the balance will be written off. This may seem a strange decision as a creditor but if the chances of arranging regular future repayments are slim then it may be the most sensible option.
The alternative might be that your creditors arrange short to medium-term loan repayments funded by the lump-sum payment.
While creditors would receive the funds over an extended period of time this would also leave open the opportunity to arrange repayment in full or extend repayment terms, in the event that the individual’s financial circumstances improved. In effect, this would allow creditors to hedge their bets.
It will surprise many people to learn of the various options available which can see all or part of an individual’s debts written off. While this would be unlikely where secured debts were involved, where the debt is unsecured, creditors may look for alternative arrangements.
They would obviously pursue repayment of all debts where the individual has the means or may have the means going forward.
However, where it is obvious an individual will struggle to make any repayments in the future the best option for all may well be to write off the debt.
How Can Love Debt Free Help?
Here at Love Debt Free, we have partnered with some of the UK’s leading Debt help companies.
They have already helped thousands of people reduce and manage their debts, and they can do the same for you.
Choosing an independent adviser means they won’t recommend a scheme unless they are sure it is in your best interests. Their advice is also regulated by the FCA, which gives you an additional layer of protection.
If you would like to speak to one of these debt help companies, click on the below and answer the questions.