Brush up on the consolidation options

When it comes to dealing with clients looking for debt consolidation, mortgage advisers are expected to have a working knowledge of the options available, says Bill Warren

Last week I looked at two issues highlighted by the Financial Services Authority in its review of smaller brokers in the sub-prime market. These were fact-finds and record keeping. The third major issue highlighted is debt consolidation and the review found 67% of firms could not demonstrate they had taken into account three key factors when advising on a debt consolidation mortgage loan – added costs, securing unsecured debt and alternative ways of tackling the debt problem.

Sub-prime lenders tend to regard debt consolidation as a legitimate loan purpose, with appropriate limits being set on specific mortgage products. A debt consolidation loan could be seen as no riskier than a loan to fit a new kitchen or bathroom as long as income multiples, LTVs and payment records are within criteria, especially if the applicant has a prime credit record. But the FSA sees debt consolidation advice as deserving specific attention and its MCOB rules on the subject apply to prime and sub-prime borrowers although the regulator’s review only covered the sub-prime market. Consumer protection bodies such as Citizens Advice that deal daily with clients who can’t manage their debts, support the FSA’s view extra care must be taken to ensure consumers who are seeking a debt consolidation regulated mortgage loan are not worsening their financial situation instead of bettering it.

The first point highlighted by the review is the conversion of unsecured lending into lending secured on a borrower’s home, which may then be repossessed if the borrower fails to keep up the mortgage payments. The second issue is that if short-term unsecured debt is converted into a 25 or 30-year loan, the amount of interest paid over the full lifetime of the rolled up debt element of the new mortgage loan could be greater than if it remained as a short-term unsecured loan.

The third point cited in the FSA review concerns whether it would be “more appropriate for the customer to negotiate an arrangement with his creditors than to take out a regulated mortgage contract”. In other words, advisers faced with a debt consolidation case must be able to show their client has considered the alternatives to a mortgage loan. An individual voluntary arrangement is one such alternative, and clients need to consider whether they can manage such an arrangement themselves or pay a professional consultant, such as a solicitor or an accountant to do it for them.

They must also be confident they can keep to the agreed payment schedule. An informal agreement with creditors is a possibility and to accomplish this the customer will need to have the organisational skills to get all the creditors into agreement and then the self-discipline to keep up the payments. There are a number of widely advertised profit-making enterprises that offer debt management services, and free advice is available from organisations such as the Consumer Credit Counselling Service, National Debtline and Citizens Advice.

So, having understood the scope of what needs to be covered when advising customers about a debt consolidation mortgage, what needs to be done in practical terms? Debt consolidation sits within the rules that deal with affordability, found in MCOB 4.7, and proof of covering the three areas of concern as listed above (and in MCOB 4.7.6) can be incorporated in the documentation designed to cover affordability in general. These include the budget planner within the fact- find. Firms should have procedures built into their systems that reflect the kind of business they advise on.

The process of covering debt consolidation advice need not be onerous and can easily be built into the routine of recording processes, especially if a good compliance software system such as Home Buyer is used.

Mortgage advisers are not expected to be expert debt counsellors or to provide detailed cost comparisons of all alternative courses of action. But they must be able to offer an adequate outline of the options and their likely cost implications. Above all, they must be able to produce a record of having done this.