Consolidation Debt Solution

What is Consolidation?

Consolidation is simply the act of paying off multiple small debts with one larger, all encompassing loan. When debts start to become a problem, consolidation is often the first solution that is considered. This is particularly as consolidation is generally the preferred solution recommended by banks who are trying to help their customers manage debt problems.

If carried out correctly, consolidation results in a single loan and a single monthly debt payment. The loan payment will be smaller (and therefore more manageable) than the previous multiple repayments added together.

Depending on the size of the original debts, consolidation can be achieved either with an unsecured personal loan or with a loan secured against a property. A secured loan would be in the form of an extension to a current mortgage or a second mortgage.

Who Should Use Consolidation?

Consolidation can be used by anyone who is struggling to repay multiple debts. There are two general tests which will determine whether consolidation is appropriate:

1) Can all of the original debts be consolidated with one loan?

If the consolidation loan available is not large enough to pay all the original debts, the desired result of a single monthly payment which is less than the sum of the original multiple repayments may be not achieved.

2) Is the consolidation loan payment affordable?

It is extremely important to make sure that the monthly repayment of any loan undertaken is affordable. This is especially the case where a business has started to fail and as a result the money which is being taken out of it by the owner is falling or is nonexistent.

Directors

Consolidation is a private agreement between the individual taking the loan and the loan provider. As such, this may be a sensible solution for a director who does not want to make their personal financial difficulties public. However, the question of whether a suitable loan is both available and affordable must be carefully considered.

Sole Traders

As with company directors, consolidation is a good way for sole traders to resolve debt problems privately and quietly as long as the loan is available and affordable.

Debt Settlement with a Consolidation Loan

Where it is possible to borrow a lump sum in the form of a consolidation loan, this may not be sufficient to repay all of the original outstanding debt. In these circumstances, it may be possible to offer the original creditors a settlement of their debt rather than a full repayment.

To achieve a debt settlement solution, the creditors will generally have to be convinced that the lump sum offer is the best that they are likely to get. A lump sum settlement can be achieved with creditors on an informal basis or within the umbrella of a more formal solution such as an IVA.

Note: The suitability of consolidation to resolve a debt problem caused by business failure will always depend on the individual's circumstances. Before deciding that consolidation is right for you, you must take professional advice.

Why not call Cooper Matthews today for an informal discussion?

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What debt can be included in Consolidation?

Any debts can be paid off using a consolidation loan. Where the loan is sufficient to pay all of the outstanding debts in full, there is no arrangement or negotiation required with the original creditors. The outstanding accounts are simply paid using the new money made available from the loan.

If the consolidation loan is not sufficient to repay all of the debt, it should generally not be used as a debt management solution unless there is confidence that settlements can be agreed with the original creditors. If the debts include crown debts such as outstanding VAT or income tax, then it is often easier to settle these as part of a formal solution such as an IVA.

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How does Consolidation Work?

The consolidation process generally consists of securing a suitable bank loan. Once this has been achieved, all outstanding creditors can simply be repaid. The options for sourcing a consolidation loan are as follows:

Unsecured Loan

If you want to borrow up to £20,000 you will normally initially consider an unsecured loan - i.e. the loan is not secured against any property such as your house.

It is generally easiest to apply for an unsecured loan through your own bank. The availability of the loan will largely depend on your credit history which the bank will check before offering you the loan.

Before accepting a loan offer, you should understand exactly how much you are borrowing including interest payments. The easiest way of doing this is to multiply the monthly payment by the total months over which the loan is payable. For example if you borrow £20,000 and pay this back at the rate of £450 per month over 5 years, you will repay £27000 in total (£450 x 60)

Secured Loan

If you need to borrow more than £20,000 it is likely that you will need to consider a loan which is secured against your property. If you do not own a house, then this option will not be available to you.

The easiest way of getting a secured loan is to consider increasing the size of the mortgage against your property. In effect this is releasing equity from your home to consolidate other debts. Because the mortgage will generally be paid over a long period (20-25 years), the additional monthly repayments are likely to be relatively small.

Unfortunately, as a result of the credit crunch, re-mortgaging has become a lot more difficult. Generally you will only be able to extend the level of your mortgage for debt consolidation purposes up to 80% of the value of the property and if your income allows this.

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The Advantages of Consolidation

There are a number of advantages of using Consolidation for company directors and sole traders:

• If you borrow money to repay debt, your credit rating will not effected as you will not be breaking any of the original credit agreements
• Consolidation is a private and discreet procedure. As such, it will not affect your ability to be a director of a company or to continue managing your business.
• Arranging a consolidation loan can be done yourself with no outside help and is relatively quick to implement given that you meet the bank's lending criteria.

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The Disadvantages of Consolidation

• Generally you can only borrow up to £20,000 on an unsecured basis. You will not be able to borrow more than this unless you can secure the debt against a property and there is available equity to do this.
• Consolidation only works if you can afford to maintain the payments for the new loan. If your income is uncertain due to a downturn in your business, a consolidation loan could be a very risky strategy.
• As soon as you take a consolidation loan, the total that you owe will increase due to the interest charged on the loan.
• A secured loan or mortgage will put property at risk if you do not maintain the repayments.

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What will Consolidation Cost?

Unsecured Loan

Normally there are no set up fees when you take out an unsecured loan. The real cost of the loan is the interest that the loan provider will charge. It can often be quite confusing to understand loan interest rates. Therefore the key to understanding the cost is simply to work out how much you will have to repay over the duration of the loan.

How much interest will I pay?

Working out how much you will repay on an unsecured loan is very simple, you just need to know how much you will be repaying each month and for how long the repayments will last.

For example, if you are borrowing £20,000 and are told you will pay £450 a month for 60 months (5 years), the total repayment will be: £450 x 60 = £27,000. So for borrowing £20,000 over 5 years, you will pay the lender £7000 in interest (or £1400 per year, or £117 per month).

Mortgage or Secured loan

Generally there will be a set up fee when taking out either a mortgage or secured loan. However, you will not normally pay these fees directly because they will be added to the loan. It is important that you understand what set up fees the lender is proposing so that you understand how these will be paid.

In the same way as an unsecured loan, the majority of the cost of taking a secured loan will be the interest payments. Remember, many secured loans are paid over 10 years (120 months) and many mortgages over 20-25 years. This means that although interest rates are likely to be lower than those of unsecured loans, the effect of compound interest (interest added to interest) will make the loan relatively expensive over the longer term.

Secured lenders have come under increased pressure in recent years to be transparent about how much their loans cost. If you are considering taking out a mortgage or secured loan, you should ensure you ask the lender for a written statement of how much you will repay if you continue to pay the loan over the full term.

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