DEBT CONSOLIDATION

There are many debt consolidation specialists but are any of them actually worth going to? Debt consolidation can seem like an easy way out when the bills get too much. What could be simpler, after all, than rolling all your standing orders and direct debits into one lump sum every month, so you know exactly how much is going out and on what date? Plus the amount leaving your account each month could be less, leaving you more money left over.

All this may be true. Debt consolidation can help people to cope with their bills and can even help avoid bankruptcy. And if repayments on the loan are made on time each month, a consolidation loan can be used to repair your credit record. But it's not the whole story.

Debt consolidation loans should come with a warning, because consolidating a lot of little loans into one big one can be a dangerous move. Before you take out a consolidation loan you need to understand two things:

1. The power of compound interest, and
2. The difference between secured and unsecured lending

Compound interest is interest which is charged on interest that has already been added to a loan. If you do not make your monthly payments in full, you end up paying interest on interest - and then interest on interest on interest...

How much you pay for a loan in total will be governed by two things: the interest rate (and how often it is compounded) and the length of the loan. If you extend the length of your loan, even if the interest rate remains the same as on your previous loans, you will end up paying more back in the long run.

Debt consolidation loans usually work by reducing monthly payments to a level that you feel you can afford. But they do this by extending the period of the loan, and at the same time making you pay more in the long run.

A secured loan which is the type used for debt consolidation, is one that is usually related to your house. The house is the security for the loan so, if you don't make all the repayments, the lender might be able to make you sell your home in order for your to pay him back.

This means that a secured loan is much more risky than an unsecured loan, which isn't linked to anything. The worst that can happen for defaulting on an unsecured loan is you could be taken to court and a judgment taken out against you - which means that in future you may have trouble getting other things such as a mortgage, credit card or other loan.

So, you can see how important it is to meet your repayments, and how the way to get the debt to go down rather than up would be to increase your repayments, not decrease them - which is what a consolidation loan will tend to do.

There are some other drawbacks to consolidating your debts with one lender:

You will now have only one creditor, which could mean you will have more difficulty in negotiating repayments if you have further financial problems in future.
The loan will probably be secured against your home, meaning you could lose it if you miss payments.
Credit card debts and personal loans are unsecured.
You may pay a higher rate of interest compared with other types of loan, particularly if you have a poor credit history.
Secured loans are usually offered on a variable rate basis so you could find your repayments soaring if interest rates rise.
If you are able to repay the loan early thanks to an inheritance, for example there may be hefty penalties payable for early repayment of a secured loan.

Other debt management options
Before you take out a secured loan you should consider other options. Maybe selling items you don't need, such as a second car, moving your credit card and store card debt to a card with a lower interest rate, or taking out an unsecured loan to cover card debt.

If you have equity in your home you could try remortgaging to release some capital to pay off your debts. This will also extend your indebtedness over a longer period, but the interest rate on a mortgage tends to be much lower than on secured loans. If switching your mortgage to another lender will result in early repayment penalties, ask your existing lender if they will grant a second mortgage on your property. This could still work out cheaper than a separate secured loan.

However, using the services of debt consolidation companies can lead to further problems, not least because they can charge high "administration fees", which are added to your existing debt. You should never pay for debt counselling or debt rescheduling.

If you have serious debt problems, you should seek advice from a free credit advisory service, such as Citizens' Advice or the Consumer Credit Counselling Service.