The debt consolidation industry

Levels of personal debt in the UK are soaring, with the average person owing a massive £24,000 through personal loans, credit cards and hire purchase agreements, according to the Consumer Credit Counselling Service, a charity which helps people manage their debts.

If you are trying to pay of debts with several different lenders and find yourself juggling cash every month then rolling all your debts into one could make life easier. Not only does it mean you have one payment to make each month instead of several, but the new, 'consolidated' debt will have one rate of interest.

Depending on how much debt you have and how rosy your credit rating looks, it may be possible to consolidate your own debts quite easily by taking out a personal loan. These lump sums which can be borrowed from banks, building societies and loan companies. The loan is usually arranged for a fixed period and interest rate, with monthly repayments made by direct debit. These are most popular for amounts between £1,000 and £15,000 and interest rates tend to fall between 6.9% and 13%. Choosing the right loan depends on how much you want to borrow and for how long. But the key is always to only borrow what you can afford or you run the risk of making your debts worse.

Debt stress

Open any newspaper or watch more than a few minutes of satellite or daytime television and you will spot plenty of advertisements placed by debt management or consolidation companies. These offer either to consolidate your debt payments so that you make only one payment directly to the debt management company, or to negotiate with your creditors for you.

Apart from the obvious attraction and convenience of making one payment, debt management companies may appeal if you are need additional support in handling your creditors. Some people find that the only way they can face up to their debts and get them under control is by letting someone else take charge. If you have been receiving worrying letters from your creditors then managing your relationship with them via the debt consolidation company may also relieve stress.

But there are also plenty of pitfalls to consider whether you opt to just take out a consolidation loan or sign up for the debt management as well. Just because that nice lady from Countdown appears in firms' adverts, it does not make it the right choice for you. Most debt management companies are only interested in customers who have some available income and own their own home, so that the home can be used as surety against the debts. This means that 'unsecured' credit card or loan debts suddenly become 'secured' against your home. Put simply, if you fail to make the repayments you could lose your home. It's that serious.

Get your priorities straight

If you need help with 'priority' debts such as your mortgage or rent, any loans secured on your home, council tax, child support, hire purchase plans or utilities costs most debt management companies will not be able to offer it although they may take you on as a customer for 'non-priority' debts such as loans and credit. This means that if your debt problem includes not being able to pay your rent as well as overdue credit card bills, the debt manager will concentrate on the credit cards and the more crucial issue of the roof over your head may be neglected.

A debt management company should start by taking an in-depth look at your finances, including your income, essential outgoings and all debts. Only then will they be able to work out a realistic programme of repayment so you can shake off your debt. If they gloss over this process, you are at risk of signing up to an agreement which is then difficult or impossible to keep to and which defeats the whole object.

Because debt managers do not generally provide financial advice you may not be aware of all the options open to you and the advantages and disadvantages of each. This also means that will not highlight any State benefits you may be entitled to so you will need to do your own research. You will also need to do your homework on the interest rate you pay on the newly consolidated loan. It will almost certainly be higher than your mortgage interest rate and could be five or six times as much or even higher. And you are paying for a service which provides nothing you cannot do for yourself or arrange for free.

The cost of consolidation

In addition to the interest, consider the payment schedule. It may bring a sigh of relief to see that your debt can now be repaid over 10 years instead of two but the debt manager is not doing this out of kindness - it is a way of making more money out of you. One of the biggest problem with debt management companies is that they charge a fee. This is usually around £200 and there may also a be an initial 'deposit'. On top of this, expect to pay for the distribution of payments to creditors, which may cost up to £30 per month. Before you sign any agreement, you need to check whether you can cancel at any time if you are not happy with the service and if you will get your deposit back. It is essential to read the small print.

It is also important to remember that debt management companies cannot guarantee a favourable outcome for you. You still need to do the work and keep up the payments. And just because a debt manager is involved, this does not mean that your creditors are obliged to reduce payments or freeze interest - they will only do this at their discretion. Having a debt manager will also not prevent creditors taking court action against you. In fact, some creditors refuse to deal with debt management companies which means you will have to maintain communication. Be very wary if your debt manager advises you to sever all contact with your creditors and pass on any correspondence. This may result in creditors taking action - including court action - against you which you do not know about.

With so much potential to do more harm than good, the £10 million debt consolidation industry is regularly at the sharp end of criticism from consumer groups. It has also been the subject of an investigation by government watchdog the Office of Fair Trading (OFT) which found that some lenders, including major high street banks, may be inappropriately pushing customers to take out consolidation loans to pay off debts. It also said evidence had been found suggesting that expensive payment protection insurance policies are being inappropriately sold to borrowers who would be unlikely to ever claim on it. The findings reveal that two-thirds of borrowers who consolidated their debts obtained information from just one financial provider. The OFT is concerned the interest charged and points out cheaper forms of credit may be available. It urges borrowers experiencing difficulties to seek advice from one of the UK's free counselling services.