Debt consolidation loans - what you must look for
FOLLOWING last week’s column on the extortionate rates being charged for credit card debt, I had some queries regarding debt consolidation loans which I’ll just clarify.
Just like the old Gombeen man, as most of you will have seen, there are many very helpful comparison sites out there keen to ‘help’, like putting a fish up a tree so it doesn’t drown in the flood.
The common sticky misconception of a secured loan is its cost. In the old days, a secured loan was always significantly more expensive than a mortgage and often the last port of call, but costs are very different now, as is the competitiveness of loans.
If you have expensive credit card debts, lowering the interest is vital. The ‘Barclaycard Avios plus’ boasts a 75 per cent representative APR. Bargain. But you do get a discounted access to airport lounges. All is good.
Naturally you should always take advice specific to your circumstances but the normal flow to solve the credit card debts would be as follows (pretty much in this order):
- Look at accessing a credit card transfer to a zero-interest, transfer free credit card for a period of time (18-33 months);
- Pay off the debt with the money you are saving each month;
- Consider a further advance on your mortgage to reduce the interest payment down to a fair level (from 22 per cent down to around five per cent). Use the 17 per cent per year saved to pay back the capital;
- If a further advance doesn’t work, consider a re-mortgage to consolidate and then finally, consider a secured loan/personal loan.
Things to watch out for! A typical secured loan costs around seven per cent per year. A two-year fixed rate mortgage is around five per cent and a five-year fixed is close to 4.8 per cent. You can see why the mortgage is a better option, but a secured loan and a variable rate mortgage are not that far apart.
The big marketing tool that sits behind comparison sites guide you/distract you toward the rate, but some of the arrangement fees for secured loans, are just plain nuts. Fogged out by your panic and need to clear your debt, is an arrangement fee of typically eight to 10 per cent. Make that make sense. We would expect the broker we use to half that.
Make sure you apply to a broker who understands the process and doesn’t have you gaining multiple checks against your credit history and then to be denied the credit. Some applications can be killed very quickly when consolidating debt, as the new lender still includes the payments and debts you will be replacing. Therefore, you fail on affordability. Use a broker that knows who to approach that doesn’t do this.
Sometimes a further advance isn’t available as lenders stop at an 80-85 per cent loan to value, some just don’t like debt consolidation, and some have a cap on the amount that can be raised for consolidation. The secured loan doesn’t have these restrictions.
Mortgage applications can typically fall over on application because of affordability on income multiples. A mortgage is typically four to 4.5 times earnings with certain lenders, also allowing five times earnings for higher earners. A secured loan provider can offer six to seven times earnings.
If you are a contractor, normal mortgage applications will need at least one, if not two years earnings, but a secured loan will simply look at the day rate the contractor is on and calculate the earnings from there. Also, unlike mortgage applications, many secured loan companies will not take adverse credit into account if it is over 12 months old. A mortgage typically needs three years clean credit history.
When applying via a comparison site, check what the early repayment charges (ERC) are on any secured loans. There shouldn’t really be any, but they can be sneaked in. Unlike a secured loan, a mortgage with a fixed rate typically has ERC’s of around five per cent, tapering down over time.
And finally, there are things to also consider with remortgaging. When you remortgage, the new rate for ‘all’ your lending could increase, as opposed to the extra you need to borrow.
You may not be able to settle the existing mortgage because of ERC’s. You may have the first mortgage on interest only and a new mortgage lender may not allow that option, and the purpose of the loan may not be acceptable to the new lender.
Either way, reduce your rate and seek advice.
Peter McGahan is chief executive of independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority. If you have a question on borrowing, get in touch with Pat Greene on firstname.lastname@example.org or call 028 6863 2692