Debt management
Dealing with debt
September 2007
There are various ways people can try to dig themselves out of debt. Steve Walker looks at the options
House price growth is slowing – but not fast enough to stop the Bank of England raising interest rates again in the very near future. That’s bad news for the two million Britons due to come off fixed-rate mortgages in the coming months.
More than £100 billion of fixed-rate lending – one-third of the national total – is coming to the end of fixed-rate deals and the majority of these were fixed rates of less than 3.75 per cent. Some are already finding the going tough. Just under 250,000 county court judgments (CCJs) were issued in the first three months of 2007, with one million expected to be issued by the end of the year. The number of CCJs has almost doubled in three years.
The figures from the Registry Trust come as bankruptcies hit their highest level since 1960 and personal debt reaches £1.3 trillion. Throw into the mix the fact that the number of individual insolvencies looks set to triple between now and 2010 and we are staring down the throat of a crisis. Around 13,000 couples in England and Wales declared themselves bankrupt or took out an individual voluntary arrangement (IVA) last year, 165 per cent more than in 2004. But the figure could rise even further to 50,000 by 2010, according to a report by the Manchester Business School for accountancy firm Haines Watts.
This is going to cause genuine hardship for many. In fact it is already doing so. The disturbing report last month that former lecturer Edward Edrich (59) shot his wife dead as she sat in her armchair because of a debt-induced depression sparked calls from a charity for brokers to refer debt-stricken clients for counselling. By offering an ethical and cost-effective way to manage the repayment of debts to multiple, unsecured creditors, intermediaries can provide an invaluable service to clients.
Consolidation loans
Historically, consolidation loans have been a popular solution, especially for homeowners. However, research has discovered that three out of five people taking on a debt consolidation loan go on to accumulate more debt.
It can therefore make perfect sense to roll up several expensive debts into one affordable monthly payment when faced with a myriad of claims on money.
However, it is prudent for the broker to suggest alternatives available to the client before entering into any consolidation agreements. Once multiple debts have been consolidated, it is not possible to reverse the process and deal with the individual debts again. Some of the individual debts may have been at a favourable rate or offered the option of early repayment. These advantages would simply be lost following debt consolidation.
Historically, it has been difficult for consumers, or advisors, to identify a suitable solution, and a ‘one-stop shop’ has not been available. However, with FSA-regulated brokers now moving into the debt management and IVA arena, together with technology to support the proposition, those in difficulty can now expect to be offered a range of ethical solutions and to be treated fairly.
One of the many options includes a remortgage or further advance. While this is an attractive option, it can often be over a longer term than the prospective borrower may desire.
Secured loans
Sitting alongside the remortgage option, a secured loan is a flexible and increasingly attractive alternative, especially on loans less than £25k where the upfront costs in arranging it are low, the early repayment charges (ERCs) are subject to regulation and are also low, and the lenders’ criteria are more accommodating for those whose finances are stretched. Beware. Those borrowers who already have an existing mortgage at a competitive rate could be penalised by opting for the remortgage route, as their status may dictate a higher overall lending rate.
For intermediaries, provided they choose the right secured loan specialist partner, the process can be very fast, the work on their part minimal and the remuneration very good by comparison to a remortgage.
Debt management
Clients that fall towards the bottom of the secured loan filter may find that, due to their circumstances, they can only arrange a loan at a significantly higher interest rate. Acceptance rates can also be quite low, resulting in borrowers needing to be touted around a number of lenders, each of which will potentially undertake a credit search.
As a result, the option of debt management can look more attractive for such clients. A reputable debt management company needs to be chosen which has the customer’s interests at heart and charges reasonable monthly fees. Where debt management and secured loans can work particularly effectively together is in negotiating full and final settlements with the borrower’s creditors, resulting in creditors writing off significant debt in favour of a lump-sum payment today from the loan proceeds. A write off of circa £25,000 is not uncommon across multiple creditors.
The combination of debt management, secured loans/mortgages and full and final negotiations with lenders often allows borrowers to avoid an IVA. Ultimately, borrowers in debt can consider IVAs or bankruptcy.
IVAs
For creditors, the idea is to enable them to maximise the money they can retrieve, which tends to be more under an IVA than it does via a declaration of bankruptcy. Creditors face writing off at least £1.4 billion in bad debts as a result of the number of people who have entered into IVAs over the past year, according to KPMG. People as young as 21 are running up debts that are typically three times their annual income, with the average IVA debtor owing £52,000 and proposing to repay only 39 per cent of this sum. This record amount of debt being written off comes two decades after IVAs were introduced. KPMG estimates around 45,000 people used IVAs to write off a portion of their debts in 2006 – an increase of more than 100 per cent on the previous 12 months.
The biggest advantage of an IVA for debtors is that, once they and their creditors have agreed what will be paid back over a set period of time, they are protected from other possible attempts by creditors to enforce payment by other means.
Brokers have a duty of responsibility to advise clients on their options – which could be to seek a solution other than an IVA – as well as outline the pros and cons of IVAs. The idea that an IVA can be a quick fix for borrowers has to be balanced against the virtues of the alternatives.
For example, it will affect their credit rating and their ability to get other mortgages in the future. Brokers should be exploring solutions with lenders such as seeking an extension of a borrower’s mortgage term, putting a loan on an interest-only basis or coming to an arrangement whereby a lender will accept reduced payments for a while.
Best practice
Best practice today means ensuring that consumers are fully aware of all elements of their loan and not glossing over critical facts. Borrowers need to know the difference between single-premium and monthly-premium insurance, including the effect of interest over the term. They need to understand the difference between regulated and non-regulated loans and the effects of differing early settlement rules. They need to know the details of how their broker is remunerated and understand fully all the costs involved in setting up their loan. They also need to understand the basis on which any particular product has been recommended, the key features, benefits, exclusions and limitations to any insurance policy and that any such single-premium policy is not a condition to qualify for the loan.
In order for a broker to be able to defend a complaint that may go to the Financial Ombudsman Service (FOS), they need to be able to prove that the borrower has received and understood all information prior to committing to the loan. And while increased disclosure, increased record keeping and ensuring all telephone calls are recorded will lengthen the process, frustrate borrowers and increase costs, loan brokers cannot afford to be complacent as to do so could cost them dearly.
Within any industry, there will be organisations that take a long-term view and those that look to get in and out quickly. There is a real danger that the ‘short-termists’ may seek to gain competitor advantage through avoiding appropriate disclosures that will undoubtedly reduce their sales costs and increase their conversion rates. This could lead to reputational risk for the industry, disadvantage loan brokers striving to act appropriately and increase customer detriment – especially if the companies concerned are no longer trading in this sector when the complaints rear their heads and FOS comes calling.
Mortgage intermediaries also need to take great care when selecting relationships with secured loan master
brokers to ensure that they are dealing with companies that are serious about the future of this industry and ensuring that both the intermediary and the borrower are properly protected.
Steve Walker is managing director of Promise Finance
Executive summary
• Consolidation loans have been a popular solution, especially for homeowners, but research has shown that three out of five people taking on a debt consolidation loan go on to accumulate more debt.
• Debt management and secured loans can work together, by negotiating full and final settlements with the borrower’s creditors, resulting in creditors writing off significant debt in favour of a lump sum payment today from the loan proceeds.
• The combination of debt management, secured loans/mortgages and full and final negotiations with lenders often allows borrowers to avoid an IVA.
• Debt solutions for those with money problems include consolidation loans, secured loans, remortgage, further advance, debt management, IVAs and bankruptcy.
• Other solutions lenders should consider include seeking an extension of a borrower's mortgage term, putting a loan on an interest-only basis or coming to an arrangement whereby a lender will accept reduced payments for a while.
Association of Finance Brokers
There’s no denying that there are good and bad practitioners within the secured loan industry – as in the mortgage industry. The Corporation of Finance Brokers (CFB) was founded in the early 80’s to raise standards. Working through a voluntary code, the CFB Directorate, comprising leading brokers, soon realised it did not have sufficient teeth to effectively stamp out illegal advertising and bad practice.
The CFB then approached lenders to form the Finance Industry Standards Association (FISA), to help ensure standards were maintained within the industry. Following the formation of FISA, the role of the CFB as a self-regulating organisation, diminished heralding a period of stability within the secured loans sector.
However, the CFB board saw the wave of forthcoming regulation and recognised the need for the industry to do more. Throughout 2005 and in to early 2006 there followed considerable hard work by the CFB board analysing the issues and how to confront them. It was clear that, going forward, any secured loan trade body would need a high degree of technical expertise, strong lobbying abilities and a robust secretariat and infrastructure.
The qualities within the Association of Independent Financial Advisers (AIFA) and the Association of Mortgage Intermediaries (AMI) stood head and shoulders above other similar bodies as an example of how to do it properly. The leaders of the loan broking industry and the CFB Board approached AIFA and drove the initiative to form the Association of Finance Brokers (AFB). This movement was ratified by the CFB membership in June 2006 and the AFB was launched the following month.
Regulation
The regulation of loans over £25k will come into force in April 2008. This will reduce early redemption penalties on large secured loans and create greater transparency for consumers. However, there will also be a significant downward effect on lender’s margins and such transparency is bound to be reflected with an increase in the interest rates payable by borrowers.
Similarly, single premium PPI, which has been a cornerstone of the secured loan industry for many years, is set to change. There is little doubt that the profits derived from single premium insurance helped to maintain lower interest rates for borrowers. It is also widely accepted that initial costs of single premium PPI need to reduce and rebate policies need to significantly improve. But again, such transparency and fair dealing will inevitably come at a cost which is likely to be shared with borrowers through high interest rates, brokers through lower commissions and lenders through reduced margins.
More recently we have seen the ruling on the Wilson V Hurstanger case. This ruling has created a contingent liability for brokers, lenders and perhaps more so, for those who have purchased a securitised book.
The case, heard in April, saw a client successfully sue his mortgage lender because his broker, who organised a £7,000 loan and charged him a fee of £1,000, had not fully disclosed the commission he was paid by the lender. The Association of British Insurers protection committee feels the case will have far-reaching implications and predicts that providers will be forced to disclose all commission paid to advisers
Since October 2005 brokers advising on residential mortgages have been obligated by regulation to fully disclose commission although the FSA says brokers advising on non-residential mortgages, such as buy-to-let, protection products and general insurance do not have to. But all fee-based advisers are obligated to disclose commission under agency law because, in the eyes of the law, the fee means they are acting as an agent of the client and if they receive commission, which the client has not given informed consent to, a conflict of interest arises.
With the Financial Ombudsman Service now arbitrating Consumer Credit Act agreements, and very much taking a consumer-biased stance, it is clear that loan brokers need to change the way they operate. However, that does not automatically mean they were doing anything wrong in the past. Many brokers simply followed the industry guidance and working practice of the day, but have now found that, due to retrospective regulation, the goalposts have not only moved, but actually moved many years ago.
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