Debt Consolidation

If the main reason for releasing equity from your home is to pay off existing debts, then you may wish to consider consolidating your debt instead.

What is debt consolidation?

Debt consolidation allows you to replace multiple loan and credit card payments with a single monthly payment. The new monthly payment is often lower than the combined value of your previous monthly payments. This is achieved in a number of ways:

• Lower interest rate applied to the oustanding loans
• Outstanding loans are repaid over a longer period
• Some debts may be written off, or a settlement may be made with creditors whereby you pay back less than the original outstanding amount

Debt consolidation loans can be secured or unsecured. Unsecured loans tend to attract higher interest rates than secured loans, since they are more risky for the lender.

Advantages of debt consolidation

• Consolidating debts can reduce your overall monthly commitments, leaving you with more disposable income.
• Consolidating your debts into a single repayment makes it easier to manage your debts, reducing stress.
• Credit cards, store cards and overdrafts often charge excessively high interest rates.  By consolidating your debts into a single loan or mortgage, your can reduce the interest rate you pay, saving you money.
• By consolidating your debts using a loan or mortgage, you can reduce your monthly outgoings without affecting your credit rating.
• You can arrange a loan with a fixed repayment term, giving you peace of mind knowing exactly when your debts will be repaid.

Disadvantages of debt consolidation

• Consolidating your debts through a re-mortgage of your home may extend the term of your mortgage, which may affect your finanical situation in retirement.
• Consolidating through a re-mortgage will also use up much of the equity you have built up in your home over the past few years.
• Consolidating your debts may not get to the underlying cause of the problem, i.e. your spending habits, and as a result you may find yourself needing a further debt consolidation in the future.
• You need to be careful when selecting a lender to help you to consolidate your debt. There are some less than scrupulous lenders out there who may be driven to make a large profit for themselves t the expense of you best interests.

What is an IVA?

IVA refers to an Individual Voluntary Arrangement.

An IVA is a formal agreement between you and your creditors (e.g. bank, hire purchase creditor, credit card companies etc) where you agree to make reduced payments towards the total amount you owe.    The creditor agrees to write-off a proportion of the total balance after 5 years.  As a result, you end up paying a more affordable monthly payment, and end up repaying less than the total amount you currently owe.

Due to its formal nature, an Individual Voluntary Arrangement (IVA) has to be set up by a licensed professional called an Insolvency Practitioner.

Advantages of an IVA

• It is a legally binding agreement between you and your creditors, and therefore helps those in financial difficulties to make a formal proposal to settle their debt.
• Monthly payments are based on affordable disposable income.
• Once the final payment is made, any outstanding debt is legally written off. The arrangement can write off up to 65% of your debts (subject to your circumstances).
• Any interest and debt charges will be frozen and creditors will be prohibited from demanding additional payments.
• Debts are settled within a reasonable and fixed period of time (normally 5 years). 
• You have an agreement with your creditors to make a single reduced payment each month.
• The agreement is fixed, meaning that creditors cannot randomly demand changes to it.

Disadvantages of an IVA

It is worth noting that if you do enter into an IVA with your creditors and you have an endowment policy linked to your mortgage then you may be expected to cash it in and pay the proceeds into the arrangement.

Likewise, if your property has a reasonable amount of equity then it is likely that a some of it will have to be released at sometime during the arrangement (usually the end), so it can be paid to creditors. 

What are Debt Management Plans?

It is very important that consumers do not confuse an Individual Voluntary Arrangement (IVA) with a Debt Management Plan, which are not legally binding.

Disadvantages of Debt Management Plans

• Although they may greatly reduce your repayments each month, you will still have to pay all of your debt back, and therefore you are merely spreading the repayments over a longer period.
• Your creditors do not have to stop adding interest and late payment charges.
• Creditors may want to review the situation.  This means that the reduced amount paid each month may only just cover the extra interest being added.  If this is the case, then the debt will never be repaid.
• Your creditors can break the agreement at any time and asked for increased payments or add further interest.
• Not knowing where you stand with creditors, may have you always waiting for that next payment demand letter to come through the post.