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Debt consolidation under OFT spotlight

OFT publishes fact-finding study

41/04    11 March 2004

Better financial awareness among consumers, and clear, accurate and relevant information from credit providers are required to make the use of debt consolidation fairer and more transparent, concludes the OFT in a study published today. The study will inform the OFT's enforcement of the Consumer Credit Act 1974 (CCA); its advice to Government in relation to the current review of the CCA and associated regulations; and its consumer education strategy.

Download Debt consolidation: report on the OFT study (pdf file 312 kb)

Debt consolidation occurs where a consumer takes out a loan or other credit agreement in order to pay off two or more existing debts. A variety of credit products can be used including:

• an unsecured loan
• an advance from an existing mortgage provider secured against property but leaving the original mortgage intact
• a second charge mortgage (a loan secured on property, from a lender other than the existing mortgage provider, that leaves the first charge mortgage in place)
• a remortgage
• the transfer of balances to a credit card (including the use of credit card cheques to pay off non-credit card debts).

The OFT estimates that, in 2002, £32 billion of unsecured lending and £8.8 billion of secured personal lending were used for debt consolidation (see note 3). This compares with an estimated £18.4 billion of unsecured lending and £2.4 billion of secured personal lending in 1999.   The value of credit card balance transfers in the first ten months of 2003 was £13.6 billion, compared with £11.6 billion for the whole of 2002. Not all of these transfers will be debt consolidations. Mori Financial Services (MFS) estimate that about 15 per cent of all transfers involve consolidation of more than one credit card balance.

The study included a consumer survey, an analysis of complaints, and a review of advertising and marketing material for products which could be used for debt consolidation. The OFT also consulted consumer advice organisations, lenders, brokers and trade associations. The key findings are:

• most borrowers do not shop around for credit for debt consolidation, although this can save money – two thirds of borrowers who consolidated debts obtained information from only one provider
• many borrowers, particularly those in financial distress, are unaware of other alternatives which are open to them, such as negotiating with creditors themselves or getting help from free debt counselling services
• borrowers do not, in the main, give due weight to factors such as the length of the term of the loan and the total cost of repayments when deciding whether debt consolidation makes financial sense for them.

The study identified potentially unfair practices, such as lenders requiring existing customers to take out consolidation loans as a way of dealing with a debt problem, volume overrider commission arrangements for some credit brokers and approaches to lending which stress speed of decision and no "awkward questions" which may not be consistent with responsible lending. These will be further investigated and may lead to appropriate enforcement action and/or further guidance.  The OFT also found a number of apparent breaches of credit advertising rules and will undertake a compliance review of credit advertising later this year.

The study examined evidence that payment protection insurance (PPI) for debt consolidation loans may sometimes be sold inappropriately to borrowers who are unlikely to be able to claim on it. The OFT will share the details of its findings with the Financial Services Authority (FSA), which is consulting on proposals for the regulation of the sale of general insurance, including PPI, for which it assumes responsibility from January 2005.

Jonathan May, director of the markets and policy initiatives division of the OFT, said:

'Many borrowers can benefit from consolidating their debts on better terms, but for others, there will be better alternatives. Our study has identified scope for further work by the OFT, the FSA and the Government to improve regulation of consumer credit, and to increase financial literacy among consumers.  We intend to look at the scope for further guidance and where lenders or brokers are in breach of the regulations, we will not hesitate to take enforcement action.'

OFT advice: what borrowers need to know

In addition to working out what they can afford, borrowers considering taking out a debt consolidation loan need to know:

• what debt consolidation is and what the alternatives are
• what the interest rate and APR is and whether it is variable
• what the overall cost of the loan is
• what the monthly repayments are
• whether there are additional features which will change the rate at which the capital sum is paid back
• what will happen if they miss a payment
• what happens if they want to repay or refinance early
• if the loan is secured on their home, the consequences of not keeping up with payments and what happens if they want to move.

NOTES

1. The study was carried out under section 5 of the Enterprise Act 2002 and launched in June 2003 (press release 80/03).

2. Proposals for reform of the Consumer Credit Act 1974 (CCA) and associated secondary legislation, including the Advertisements Regulations, were set out by the Government in the White Paper Fair, Clear and Competitive: the Consumer Credit Market in the 21st Century, and the consultation paper Establishing a Transparent Market, both published in December 2003. In addition to its enforcement of the current Act and Regulations, the OFT has been and will continue to work with the Department of Trade and Industry (DTI) on the reform package and advising what amendments to current law are necessary.

3. Estimates are based on data provided by the Finance and Leasing Association (FLA) Annual Consumer Finance Survey 2002. There is little official data provided about debt consolidation. The FLA survey covers (approximately) the 20 per cent of all unsecured and secured personal loans accounted for by their members.

Credit card balance transfer data is provided by the British Bankers' Association.

4. Volume overriders are additional payments made by lenders on the basis of business volume and profitability.  The OFT's Non-status Lending Guidelines (NSLG) already discourage the use of volume overriders. The OFT will consult on the approach taken towards to volume overriders as a part of a general review of the NSLG. This review will look at the content and scope of the guidelines, including whether there is a need to extend parts of the guidelines to all borrowers and unsecured forms of lending.

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