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What is your understanding and process when it comes to offering a debt consolidation loan to refinance a client’s existing liabilities?
Our research suggests the majority of brokers are well-versed in explaining the purpose of such loans, yet as a personal loan provider, we receive ongoing requests for debt consolidation loans that fall outside lender's guidelines, rendering them ineligible. Why so?
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Before serviceability is even considered, there appears to be a fundamental misconception as to when a lender would consolidate debts. From our experience, there is a well-ingrained assumption by consumers and some brokers that virtually any debt can be refinanced. Unfortunately, this is by no means correct and we suspect that this assumption has stemmed from the multiple debt-repair organisations spruiking their services, often using the term ‘debt consolidation’ to explain their core business – thus causing the misperception that the term ‘debt’ refers to any form of liability, including debts in arrears or over the limit. In these cases, debt-repair agencies may be able to help those with delinquent debts. However, debt-consolidation loans offered via banks and non-banks are a fundamentally different facility. Just because each institution uses the term ‘debt consolidation’ to describe a product does not automatically mean their structure, purpose and target market are in any way the same.
The line in the sand for eligibility of a debt-consolidation loan is determined firstly by the type of debt held and subsequently by the owner’s conduct of that debt. The type of debt points squarely at a consumer’s credit report. Frequent use of payday lenders and entries such as defaults invariably excludes a debt-consolidation loan as an option. Any debt being considered will then have its conduct assessed, generally by provision of the past three months' statements (but this is at the discretion of the lender). Furthermore, for a credit card (revolving credit) debt, not only are timely repayments required, but they also must have remained within the agreed limit. For debt-consolidation loans, the process of reviewing statements to confirm good conduct is pertinent, and where this cannot be demonstrated, we recommend that customers show this is sustainable and reapply in three months.
So, if a debt consolidation loan is not designed to repay certain debts, and particularly not delinquent ones, what real purpose do they serve? Lowering the cost of capital and/or reducing the repayment amount each have benefits, including an increased disposable income. From this, opportunities arise to establish a savings plan to achieve home ownership, helping when two incomes become one when a child arrives and to repay the debt earlier.
In essence, they serve as an invaluable product for those clients adept in maintaining their financial responsibilities, but who now need to refocus their cash flow for future goals.
My industry experience over many years reaffirms that consumers are not necessarily aware of their current position and what lenders consider as good conduct, and opt for a debt-consolidation loan to resolve their cash flow issues. This lack of awareness can impede this option if a consumer has neglected their financial obligations, in which case they must expect to ride the storm and show evidence of responsible conduct, before expecting the debt consolidation ‘life boat’ to arrive.
Effectively, there is a role for both lenders and brokers to educate consumers to understand debt consolidation and what a debt-consolidation loan is. Being flippant with these terms can cause unjust hope and lead to frustration by the customer. To avoid this, it is important to distinguish whether a consumer needs assistance from a debt-repair service or would benefit from a debt-consolidation loan.
