Danger of putting loans in one basket

They seem to dominate the adverts on daytime television. They can offer even those with a poor credit history tens of thousands of pounds. And they are the single biggest area of concern for some charities.

Debt consolidation loans are marketed to repay - or consolidate - other debt. They offer to lend homeowners up to 125 per cent of the equity in their home with the aim of paying off or reducing other debts.

For those families crippled by debt and unable to make even the minimum payments on store cards, personal loans, credit cards and other credit agreements, they appear to promise a worry-free future with only one creditor.

The reality is often very different.

Amy Brown, of debt charity the Consumer Credit Counselling Service (CCCS), says: 'It is probably our single biggest area of concern at the moment. One of the reasons is because there is nothing to guarantee borrowers use the equity raised to pay off their debts. Also, in many cases, borrowers will not have changed their behaviour - they will not have cut up their store and credit cards, and in no time will be in as much difficulty as when they took out the loan, but with their home riding on making the repayments on it.'

Richard Gale, manager at debt charity National Debtline, says: 'You can argue a case for them in certain circumstances, but they don't solve any problems. There are very few situations where we recommend switching "soft debt" to secured debt.'

Debt consolidation loans are secured borrowing, so using them to pay off your credit cards, for example, is a high-risk strategy. It turns relatively low-risk debt into an arrangement where you can lose your home if you default.

If borrowers do fall into this trap, not only will they have to face the emotional trauma of homelessness (and, according to the CCCS, it is families with young children who are most likely to be tempted by the loans), but it will be considerably harder after this to get back on the financial straight and narrow.

Brown says: 'If your home is repossessed, it often won't be sold for its full market value, which can compound the families' problems. Also, once you lose your home, it will be very difficult to get a mortgage and other financial products in the future.'

One of the other key worries over debt consolidation loans is whether or not the majority of borrowers fully understand the risk they are taking. Arguably, the typical borrower is not highly finan cially sophisticated. Brown says: 'A lot of people we see that have taken out debt consolidation loans have not fully grasped the risks of taking out a secured loan and have not assessed the difference in risk between secured and unsecured borrowing.'

Gale points out that each loan document will have a risk warning, but it will often be in the small print and then the chances are that borrowers won't read it. The interest rates charged by the loans do not seem that scandalous - for example, Ocean Finance says its typical APR is 10.7 per cent and compared with store cards which can charge as much as 30 per cent, this seems reasonable. But these products are used as mortgages and compared with the interest rates charged on many of today's deals, at between say 3.5 and 5 per cent, the rates do not look so cheap.

If people are struggling under today's economic conditions, then the numbers being pushed into the debt danger zone and tempted by debt consolidation loans are likely to increase now that interest rates are on the way up.'It is a real concern - even if interest rates return to historically normal levels many people will have serious problems keeping up their mortgage repayments,' says Brown.

A further problem, as far as debt charities are concerned, is the fact that the loans are unregulated.

Brown says: 'They seem to have fallen by the wayside in terms of regulation. We would like the Government to look into the way these products are marketed and ideally would like to see debt consolidation companies have a duty of care to ensure the money raised is used to pay off debts - this might involve the money being paid directly to the existing creditors.'

The good news is the Office of Fair Trading is in the process of undertaking a market investigation of the products.

It is possible that the OFT will give the market a clean bill of health; alternatively it could uncover competitiveness issues and refer the case to the Competition Commission.

But it is also within the OFT's power to recommend changes to legislation regarding such products, push for the industry to run an information campaign, or issue its own guidance.

The OFT is expected to give its verdict in the New Year.

If you or a loved one are struggling with debt, both the CCCS and National Debtline offer free information and advice.

Tough habit to break

The CCCS describes a recent case which it says is a typical scenario of debt-consolidation borrowing:

'There is a couple in their early 30s, living in Sheffield, both in white-collar jobs. Their net combined monthly income is ?2,000 and their home is worth ?80,000. On their first mortgage they had ?38,000 outstanding.

They took out a secured loan for ?36,000 - almost exactly the amount of equity in their home, which could be viewed as a very cynical move by the loan company.

The couple did not pay off all their debts with the loan and they did not change their borrowing behaviour. They ended up having to pay their first mortgage, the debt consolidation loan, seven unsecured loans, including their bank loan and overdraft, which would take them about 27 years to pay off alone and totalled about ?28,000.

Part of the problem was once they had taken out the loan they became prime targets to be offered more credit. Ultimately, the minimum repayments on all of their debts threatened to outstrip their monthly income, even before any other costs such as food and travel were taken into account.'

The debt consolidation companies reply:

Firstplus: Consolidation of short-term credit can significantly reduce the interest paid on your borrowings, if you understand how to make the most of it. Our customers typically reduce their monthly credit repayments by about 50 per cent. We lend only to financially stable borrowers with at least three years' proof of faultless credit, and make extensive checks to ensure they can afford to meet their monthly repayments, even if rates rise. Less than 0.2 per cent of our customers ever fall behind on their repayments (the industry average is over 20 times higher), which proves we lend responsibly. We have never repossessed a prop erty. All our literature makes the loan's secured nature clear and we speak to every customer to ensure they fully understand their loan before it is approved.

Ocean Finance: For many, secured loans are the most appropriate and cost-effective option. Before making any loan, Ocean Finance checks the financial position of its customers to ensure that the agreement they are entering into is appropriate. The risks involved if payments are not kept up are made very clear to all customers. When a customer approaches Ocean Finance to make an inquiry they are sent a full Fisa (Finance Industry Standards Association - the industry's self-regulatory body) brochure which explains all elements of the process. Our customers also receive a video explaining all that is involved and about Ocean Finance, and at the point where an offer is made to the customer they receive a further copy of the Fisa brochure.

More contacts

The Consumer Credit Counselling Service 0800 138 1111
National Debtline: 0808 808 4000