January 4th, 2018
As a mortgage broker, you can provide assistance to your clients to ensure that their credit facilities are meeting their current needs and objectives. Debt consolidation is a very helpful service which can help clients manage their money more effectively and potentially save on high-interest debts.
What is debt consolidation?
Debt consolidation is a term used to describe bringing all existing debts together into one new debt. It is often an option for clients who have many liabilities that they are struggling to manage. This could be because they find it hard keeping on top of the multiple repayments, they have debts with very high interest rates, or because they have just over extended themselves on what they can afford to repay.
Debt consolidation is typically achieved by taking out a personal loan and paying it back over a set term – however there are other ways to go about it, such as a home loan refinance for example. It is paramount that when you assist your client with any loan product, you have discussed the risks and costs involved. These considerations enable you to evidence that this option is not unsuitable, meets your client’s needs and objectives, and that they can repay the loan without substantial financial hardship. These are your obligations under NCCP.
Why would debt consolidation be an option?
Usually, debt consolidation is required to make it easier for the client to pay back their debts. However in some instances, the objective of a debt consolidation may be to reduce a client’s monthly financial liabilities to improve cash-flow, or to help them to qualify for a home loan.
Other reasons for debt consolidation may include:
Simplicity: Only one repayment instead of juggling multiple repayments. This could reduce stress for the client and reduce the incidence of extra costs like late payment fees and penalties.
Savings on interest and fees: Debt consolidation could potentially reduce the amount of interest owing on high-interest facilities like credit cards and save money on fees for multiple credit facilities. This may make it more affordable to pay back the debts.
Lower repayments: Reducing the interest rate and spreading out repayments over time could potentially reduce the monthly repayment amount due. This could assist a client to escape a debt trap – where all their disposable income goes on repaying debts and they need to use credit to cover living expenses, thereby running up more debt.
Your compliance guide: Things you need to tell your client
When discussing any loan or credit facility with a client, you are obliged to discuss both the pros and the cons. For example:
If you are using debt consolidation to clear credit card debts, the credit cards should ideally be cancelled. The client would need to be advised that if they continue to use the credit cards, they could end up in further debt and worsen their financial situation. We recommend you assist your client to close the credit card facilities and document your actions and conversations.
No matter what loan product you may use to consolidate debts, reducing the monthly repayment amount could potentially mean your client is in debt for a longer period of time. This could result in your client paying more interest and costs than they would have incurred by paying off the debt in a shorter time frame.
Use caution when considering consolidating your client’s debt into their home loan. The debt repayment term will be extended for the life of the home loan and it is likely that they will pay considerably more interest as a result. Also, your client will have a lot more at stake if they run into financial difficulty in the future. We recommend you advise your client to make additional home loan repayments to pay back the refinanced debt amount as quickly as possible if their new loan allows, or to start a savings account to build up a safety net if they need it in the future.
It is important to make sure your client is fully aware that with debt consolidation, they are not solving the problem of debt, just easing the symptoms. You must advise your client that debt consolidation is designed to help them clear their debt and also what would happen if it is not used the way it is intended. This will enable your client to make an informed choice about their options.
We also recommend that you encourage your client to create a budget to ensure the debt consolidation measures will work effectively for them. You can find a great budgeting template on the ASIC MoneySmart website that could help.
Evidence is key.
Please ensure you are documenting the conversations you have with your client about consolidating their debt. If you are asked to evidence what discussion you had with your client, you will need to be able to provide detailed notes, emails and other correspondence to prove you have met your responsible lending obligations under NCCP.
Want to find out more?
Speak with your local Connective Broker Support Manager to find out how you and your clients could benefit from using the custom-made CRM in our IT Platform Mercury to better support your customers. They’ll also explain how our Compliance Support Managers can help with difficult issues and scenarios.