Guide to consolidating debts

Debt worries affect millions of Britons

Debt consolidation has mushroomed in recent years, with Office of Fair Trading research showing a doubling to £40billion between 1999 and 2002. Meanwhile, £2.5billion of credit card balance transfers in 2003 involved consolidation of debts, according to Mori.

Debt consolidation can involve one or more of the following:

- Unsecured personal loans, where you go to a bank or another lender and borrow a sum of money to pay off all other loans. Because the loan is unsecured, you do not risk losing your home in the event of a default.

- An advance from your existing mortgage. You are simply borrowing more money from the same lender, secured against your property, and your home remains at risk.

- A 'second charge' mortgage, secured on property, from a lender other than the existing mortgage provider. The second charge lender takes its slice of debt after the 'first charge' lender has been paid back.

- Remortgaging a property to borrow more. You switch your home loan to a new lender and borrow more money. Such borrowing has been common in recent years, based on the rising equity in properties.

- Transferring various credit balances to a credit card, often at 0% finance, including the use of credit card cheques to pay off non-credit card debts.

Benefits of debt consolidation

The potential advantages of debt consolidation over multiple credit agreements can include lower interest rates, lower monthly payments and/or having to deal with only one creditor.

Disadvantages of debt consolidation

The costs of settling an existing loan, such as redemption penalties, and arranging a new one can be significant. Payment protection insurance (PPI), on which interest is also being charged, is subject to the same redemption penalties.

Importantly, debt consolidation loans can charge lower monthly payments because the debt is spread over a longer period of time. But you pay more interest overall and your home is at risk in the event of default.

Many loan providers 'piggyback' expensive PPI on their loans, sometimes without borrowers understanding what they are paying for.

Questions to consider before taking out a consolidation loan

1. The alternatives - these can include renegotiating existing payments on your debts.

2. The interest rate and APR - and whether it is variable - many 'consolidators' donÂ’t offer fixed rates.

3. The overall cost of the loan, including how much interest will be repaid over the full repayment period.

4. What the monthly repayments are and whether they include insurance.

5. Whether there are additional features that will change the interest rate at which the capital sum is paid back, for example non-payment.

6. What happens if you want to repay or refinance early. Many lenders impose redemption penalties - some more expensive than others.

7. If the loan is secured on your home, what the consequences of not keeping up with payments might be and what happens if you want to move. Some lenders will insist on their loans being repaid in full before you move.