Consumers could save money by consolidating debts

With the UK economy currently buckling under the weight of £1.45 trillion of total personal debt, reducing borrowing levels in the most economical way possible must be the number one priority for consumers in 2009. Borrowers currently pay out £98 billion in interest each year, yet new research from uSwitch.com reveals that consumers could save themselves £20 billion by consolidating all their unsecured debts (credit cards, overdrafts and unsecured loans) into one lower cost form of credit such as a loan or credit card. The average household could save £803 in interest in five years by consolidating to a best buy loan and making just one fixed payment every month. For many borrowers, this debt management solution could mean the difference between sinking and swimming in the tough times ahead.

The consolidation clock really is ticking for consumers. Already this year six unsecured personal loan providers have bucked the trend of the ever decreasing base rate by increasing rates by 2% (Smile, Co-Operative Bank, Furness Building Society, Derbyshire Building Society, Stroud and Swindon and Cumberland Building Society). This could have a serious impact on those looking to consolidate and simply means that consumers must act fast to get a competitive deal.

Consolidation pays: the average debt of £9,255, including £1,384 on a credit card, £7,194 on a loan and £677 on an overdraft could end up paying £2,783.39 in interest alone over five years. Consolidating these debts to a best buy unsecured loan (such as Sainsbury's finance at 8.2% APR) would save someone £803.39 in interest over five years.

Consumers wishing to consolidate their debt must, however, approach it in a disciplined way in order to avoid the pitfalls which can lead to a vicious debt cycle. Research by uSwitch.com reveals that less than one in four (23%) borrowers closed down existing debts that should have been cleared with the consolidation loan. What's more, 26% of those who did not close down existing debts when consolidating went on to accrue further debt on top of the newly granted loan amount, amounting to an average of £2,221 - an additional £744 million of borrowing. The research also revealed that providers are doing little to curb this practice. Of the 1.3 million borrowers who were granted a debt consolidation loan last year, 85% of these were not asked about closing down their other debts which amounted to an average of £6,183.

The debt-dilemma landscape

According to Credit Action, last year saw a daily increase of £175m in UK debt, and one person every 4.8minutes was declared bankrupt or insolvent. In 2007/8 the Citizens AdviceBureau saw 1.9 million clients with 5.54 million issues last year, of which 1.7million issues related to debt (31.3% of all enquiries). Debt is the number one issue advised on in bureau and equates to 4,760 new debt problems every day of the year. The most recent figures for July to September 2008 (Q2 2008/9) show a51% increase in new mortgage and secured loan debt-related enquiries and a 10%increase in fuel debts compared to the same period last year (Q2 2007/8).

Louise Bond, personal finance manager at uSwitch.com comments: "As we embark on what is expected to be one of the toughest years in the history of the UK, it is vital that borrowers give themselves the best possible chance of servicing their debt in the most economical and manageable way possible. If consumers are careful about managing their spending, a debt consolidation loan can help to reduce monthly repayments, and it can also help to settle borrowings earlier as the repayments are fixed and set for an agreed number of years.

"Borrowers need to be aware that taking out a loan or credit cards to consolidate debts must be approached in a disciplined way and should not be treated as a quick-fix solution to debt problems. Those who consolidate their debt into a single loan should only borrow enough to cover all their debts and no more, and all existing debts must be closed down immediately. The purpose of a consolidation loan is to reduce debts - consumers should not be tempted to fall into the trap of racking up these debts again as they could end up finding themselves in a vicious debt-cycle."

Consumers shopping around for a consolidation loan now, compared with a few years ago, will experience a very different credit landscape. The days of cheap and easy access to credit are a thing of the past and lenders are imposing highly stringent lending criteria. In addition, borrowing rates, even in spite of three recent cuts to the base rate, are heading in the opposite direction. Even consumers with an impeccable credit history will be hard pushed to secure a deal that offers a rate of less than 8%, and those with a less than perfect credit history will undoubtedly struggle to secure the best deals. Worried borrowers can also contact the Citizens Advice Bureau or one of the debt charities such as the Consumer Credit Counselling Service for free support and debt advice.