Posted on: May 9, 2023
Is Debt Consolidation Advisable?
11-07-2023 Correct at time of publication, but subject to change
Consolidating debt may reduce your outgoings now, but you may end up paying more overall.
YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTAGE.
Many borrowers see debt consolidation as a win-win situation. They can reduce outlay and increase spendable income and if capital raising can put some cash in the bank. But is this a good idea?
A professional mortgage advisers first approach should be that debt consolidation is not considered best advice unless they can prove it is in the borrowers interests, or that there are lifestyle choices now that demand the need for consolidation. These lifestyle choices should only be short-term, such as school fees or home improvements. And still an adviser must challenge the borrowers thinking and point out the disadvantages.
An adviser will look at a borrowers circumstances to try to understand the underlying cause for the debt accruing. If it is a fundamental budgeting issue, then consolidation may only paper over the cracks and not address the real issue. Failing to address the underlying cause will almost certainly mean further financial hardship in the future.
Here are some points a borrower should consider when looking at debt consolidation as an option…
· Consolidating short-term debt into a longer term debt secured via a mortgage on your property will almost certainly cost more in interest over the extended mortgage term. Whilst shorter term unsecured debt generally carries higher rates than secured mortgage rates, the extended mortgage term will mean a higher overall level of interest. It is fair to say this is not always the case, but your adviser should be able to work out if you are incurring higher levels of interest.
· Taking unsecured debts and securing them on your property leaves you exposed to losing your home if you fall into arrears. Keeping debts unsecured reduces these risks.
· It is generally accepted that consolidating debts with less than 2 years remaining is almost always not advised.
· Similarly consolidating interest free credit is always a bad idea.
· Consider why you want to consolidate? Some clients we see could easily reduce outlay by adopting other solutions such as reducing luxury and lifestyle outlay, shopping around for utilities and services, reducing and challenging bank charges.
· Habitual debt consolidation on an ongoing basis is most certainly not advised. Debt consolidation can be considered as a one off, but doing this multiple times will not address the underlying budget deficit issue. So eventually something will give. This could be missed payments, financial difficulty and in the worst case losing your home.
· Why am I consolidating my debt? Is this just habit, or convenience or is there a genuine need?
· Why have I accumulated debt? This will be because your expenditure has exceeded your income. But why is this the case?
· Is it advisable to fundamentally look at your budget. This will ensure you know what you spend, that you don’t spend unnecessarily and stop this financial situation coming up again in the future.
· Can you restructure finances to pay them off quicker at a lower interest rate rather than spreading payments over the term of your mortgage.
· Do not use capital raising on your mortgage to buy a car. You will have the debt for the term of your mortgage, but the car will long since have been disposed. And what will you do for the next car purchase?
Clearly this is a complicated area, but a qualified independent mortgage adviser should be able to give you guidance.
Here are some tips for reducing outlay
- Interest free credit cards – credit companies will offer interest free periods for considerable periods if you make a balance transfer. Whilst there can be an initial fee to transfer, the saving in interest can be considerable and can allow all of your payment to go towards capital reduction, rather than being swallowed up with interest.
- For short-term low cost projects credit card companies also offer interest free periods on purchases, so if what you need can be paid for with a credit card this can be a consideration.
- Look at your budget, what do you spend on utilities, insurance, TV subscriptions etc can you get them cheaper?
- And from a budget point of view, where do you shop for groceries and what groceries do you buy. You can save significant amounts by switching supermarket and brands.
- Luxuries, what do you spend on them and do you need them?
- Always challenge what you pay and ask “can I get it cheaper” and “do I need it”
- Bank charges for overdrafts and late payments can be extortionately high. Ensure you meet your monthly payments on time to avoid penalty charges and try to avoid overdrafts unless they are at 0% or a very low interest rate.
