The dos and don'ts of debt consolidation

Which way to go?

Remortgaging, extending your existing mortgage, taking out a secured loan or a personal loan are the consolidation routes available. If you are not a home owner then your only option is a personal loan, unless, for instance, you have an amazing art collection or rare vintage car against which a loan could be secured. Which route you choose depends on your personal financial circumstances.

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Going for a bigger mortgage may appear to be the least expensive way of consolidating debt but you need to consider the timeframe. The comparatively low interest rate could still turn out to be an expensive exercise when a payback period of, say, 20 years is factored in. You could end up paying nearly twice as much as you would do for a five-year personal loan. And don't forget the administration fees (and possibly exit fees if remortgaging) attendant to the mortgage process.

A secured loan is a popular debt consolidation choice, but again there are pros and cons. The loan is generally granted quickly and is usually easier to obtain, particularly by borrowers with poor or blighted credit ratings. Larger sums can be borrowed, compared to a personal (unsecured) loan, and paid back over a longer period (the loan term can vary from three to 25 years). Your house provides the security; if you do not own it outright then the secured loan becomes a second charge (after the mortgage) and the terms of the loan become more expensive interest at 8% and upwards.

As with a mortgage, if you fail to keep up payments on a secured loan you risk repossession of your home. When there's no home or other substantial asset to act as security, a personal loan is your only option for debt consolidation. Repayment periods can range from one to seven years, with sums borrowed up to £10,000. For instance, £5,000 loans over three years are currently advertised at around 6.5% to 7%. Whether you get such an APR though will depend on your credit history.

Is your credit good?

Lenders are now tightening up on personal loan availability; just one late payment on a previous credit agreement could put you at risk of bring refused money. Take the necessary steps to improve your credit rating and be a better risk: you need stable employment and income, the same address for at least two years (which tallies with your details on the electoral roll), a bank current account and a history of making payments on time, preferably by direct debit.

Have you been refused credit? You may still be able get a loan.

You also need to hone your budgetary skills - otherwise debt consolidation could prove a fruitless strategy. Identify all your monthly, quarterly and annual out-goings in order to accurately assess the financial picture. Itemise expenditure on a weekly basis - write down what you spent and why - and constantly review the situation, looking for areas of potential saving. Cut up and bin all credit and store cards unless you can justify, on strict economic criteria, their continued use. Wherever possible, pay with real money; you'll be more aware of parting with it.

Careful debt consolidation and sensible budgeting could put you back in the black sooner than you think.

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Stewart Farr
18 October 2007 © Moneyextra.com

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