January 9th, 2018
Consolidating debt may seem simple, but there’s often a lot more at play then there first appears. Becoming an expert mortgage broker is about more than just picking the lowest rate for your clients or figuring out who can approve the loan. You’ve got to understand the hidden consequences of your recommendations and guide customers to change their behaviour as well.
Consolidating debt can mean paying more interest
If you’ve got a customer with a $30,000 personal loan over 5 years at 15% p.a. then it’s a no brainer to just refinance this into their home loan right?
Actually, it’s not that simple.
$30,000 at 15% over 5 years will cost the customer $12,822 in interest. Whereas the same $30,000 at 5% over 30 years will cost the customer $27,977 in interest.
You’ve lowered their repayments, but you’ve just taken a big chunk out of their equity to do it.
Don’t turn a short term debt into a long term one
The problem is caused by extending the term on a short term debt like a car loan or personal loan and extending it over the term of a home loan. So if you’re consolidating debt then you should set it up as a separate loan account and try to limit the term on this account to around 5 years.
Ask them what’s more important: a lower repayment or to save as much as possible on your home loan? In addition to that, if the customer really does want to extend the term to over 30 years, then you need to make sure they are aware that this will actually cost them more.
Not all debts are as bad as each other
Credit cards are the worst. By a long way. It’s not even close. When you compare a credit card to a car loan or personal loan you’ll find that they tend to have:
Higher interest rates
An unlimited term – most customers don’t even try to pay them off
The minimum payments of around 3% per month drop as the balance drops, so the ‘term’ just keeps extending
Interest free periods have hidden catches, which mean customers usually end up paying interest on them.
Higher interest on cash advances, plus the hidden trap of having to pay off your other purchases before being able to pay down the cash advance.
What if you can’t consolidate all of the debts?
Sometimes a customer won’t have enough equity to allow you to consolidate all of their debts into their home loan. So as a general rule, you should consolidate debts in the following order of priority:
Personal loans with small balances
Large personal loans
Why? Credit cards are the most expensive and the most likely to cause the customer to get into trouble again. A personal loan that’s almost been paid off will have a low balance, but will have high repayments as it’s near the end of its term. So you can have a big impact on the customer’s cash-flow by consolidating it.
Where a customer is in serious financial trouble, a debt negotiator can sometimes agree with creditors for them to accept writing off around 40% of the debt where the rest is consolidated into the home loan. This is a good backup solution where a customer is at risk of losing their home because of unsecured debt.
How did they get into this mess in the first place?
Have you looked at the borrower’s cheque account? Can you be sure they don’t have a gambling problem? Are they living beyond their means?
Large amounts of unsecured debt is often a symptom of another disease. If you treat the symptoms without treating the real problem, then they’ll be calling you in a year asking for a loan increase.
You need to have a frank conversation with your customer about changing their behaviour. Spending is like an addiction, so having the customer’s repayments match their pay date can be an effective way to prevent them from overspending.
In some cases you need to make the customer aware that they’re out of equity. If they rack up debts again then they’re at risk of losing their home because you can’t keep consolidating their debts. If they’re not aware of this then they’re almost guaranteed to get into the same situation again.
Did the cards get closed?
When a debt consolidation loan settles, in most instances the credit cards actually stay open! The bank sends a cheque to the credit card company and the balance gets paid off, but the account is still there.
You should follow up with your clients by asking them to close the card and send you confirmation as well. Don’t forget to remind them to use up any credit card points before they close the account.
Don’t be afraid of non-conforming loans
Time and time again I hear brokers say that they don’t have non-conforming clients or that they don’t do non-conforming loans. What they’re really saying is that they themselves don’t believe in specialist lending. I know a lot of top brokers with high net-worth clients and they all use specialist lenders.
When it comes to debt consolidation, the good news is that some non-conforming lenders ignore missed payments on unsecured debts. So if their home loan is paid on time they can still get a sharp rate.
You should talk to customers about the weekly difference in repayments and that it’s a two-step strategy. The ultimate goal is to get them to a prime interest rate once they’ve had a clear repayment history for a year or two.
We recommend that you have a discussion about clawback with the client and come to an agreement as it’s not fair on you if you refinance the loan six months later and have your commission taken back.
Customers can often act too late
In many instances, a customer will call you when they’re well behind on all their debts and have a few defaults as well. If this is the case, they’ll end up with a non-conforming loan at a much higher rate. If that same customer had called you 6 – 12 months earlier, they may have stayed with a prime loan.
How can you avoid this happening to your clients?
You can look at your ‘payment arrears’ in your commission statement in Connective Mercury each month and call your customers before their debts become a bigger problem! You can also use Mercury to task yourself to check up on customers who may be living on a tight budget to check that they’re doing OK.
Find out more
Want to ensure you’re remaining compliant whilst providing debt consolidation services to your customers? Read this recent article from the Connective Compliance Team to find out more. If you want to find out more about Mercury’s fantastic CRM and how it can help you take care of your customers, simply talk to your local Broker Support Manager.
Otto is the Managing Director of Home Loan Experts and has been a member of Connective for over 10 years. Home Loan Experts (Australian Credit Licence: 383528) has won Major Brokerage of the Year (Non-Franchise) and Otto has twice been named Australia’s Brightest Broker in The Adviser’s Broker IQ Competition. Home Loan Experts is also a finalist in the 2017 Connective Excellence Awards for Brokerage of the Year >5 Staff.