Debt management companies: Worth the risk?

By Emma Tyrrell

09 February 2005

By now the dreaded post-Christmas credit card bills should have dropped on to doormats around Britain.

Most of us will greet them with a long-suffering groan, open them with trepidation (or hide them in a drawer for a bit and then open them with trepidation), and pay off as much as we can. But for some people these hefty bills are more than just a seasonal irritation. For those already teetering on the brink of a debt abyss, they can be the final push that sends them plummeting over the edge.

Total UK household debt, including mortgages, consumer loans, overdrafts and credit cards, passed the £1 trillion mark last summer. That's £1,000,000,000,000 - or about £16,700 for every main woman and child in the country. And we're not all managing our debts well, either.

Take a look at Yahoo! Finance's Dealing with Debt site, for help and advice on debt issues

The National Consumer Council estimates that one in every four people of us struggles to pay household bills and meet credit repayments. One in five people are even borrowing money to pay those household bills. Home repossessions and arrears are on the up, with lenders' court actions for repossession up 16 per cent last year to 77,818 - the highest since 1999. It is estimated that at least one in four of us don't even know how much we owe.

On top of all this mounting debt it's hardly surprising that the Christmas credit card bills should prove the final kicker.

For many people the answer is to turn to one of the debt management companies busily advertising their services in newspapers and on daytime TV. The largest and best-known include Baines & Ernst and Gregory Pennington.

Debt management firms typically offer to reduce your payments to one “affordable monthly amount”, an attractive prospect for someone struggling to meet their existing bills.

The company will negotiate with your creditors on your behalf to try and get them to agree to lower your repayments, and sometimes freeze interest. You pay your monthly amount to the debt manager, and it will divvy it up between your creditors.

So far, so great. The drawback is that most debt managers will charge you a hefty fee for their services – services which are actually available free elsewhere.

Typically debt management companies will take your entire first monthly payment to them as an initial fee. Thereafter they'll take anything from around 15 per cent a month up. The initial fee instantly puts your account into arrears, while the monthly fee inevitably reduces the amount going to your creditors, making your debt last even longer.

Two debt management firms wound up by the Department of Trade and Industry last year were taking up to 44 per cent of clients' monthly debt repayments, with the heavy fees meaning it would take their average client 37 years to be debt free.

The debt management industry was forced to clean up its act several years ago, after concern that customers were not being told the effect the charges would have on their debts, or that the result of lower monthly payments would be a longer lasting debt. There were also worries over some companies telling their clients not to contact or correspond with their creditors directly again. Creditors who were unhappy with new repayment arrangements “negotiated” by the debt managers had no way of letting clients know this.

The Office of Fair Trading introduced rules to sort out these and other problems in 2001, and since then the number of complaints have fallen.

The fact remains, however, that a great many people are still paying for a service that they could get free elsewhere.

Debt advice charity the Consumer Credit Counselling Service (www.cccs.co.uk), the Citizens Advice Bureau, National Debtline (www.nationaldebtline.co.uk), and fee-free debt management company Payplan (www.payplan.com) are among a number of organisations that can negotiate with your creditors and set up a debt management plan for you free of charge. Payplan and the CCCS will even handle your payments for you, asking your creditors to pay them a voluntary fee to cover their costs, rather than taking a fee from your monthly repayments.

John Fairhurst of Payplan says his organisation and the CCCS do everything that the fee-charging debt managers do, but are free.

“We would actually argue that our service is more full than that of the fee chargers, as we will first concentrate on budgeting advice, and income maximisation – making sure that you are getting all the benefits that you're entitled to, and that you're on the right tax codes, for example. We tend to find that once we've helped with those areas, probably only 25 to 30 per cent of people will need help with a repayment plan,” he says. “Arguably the fee-chargers are going to be more focused on those people with a debt servicing income, because that's where they make their money.”

Frances Walker of the CCCS agrees that fee chargers don't do anything that the CCCS can't do. “We would also argue that our advice is often better because we are independent, whereas fee chargers are often tied up with certain insolvency practitioners and loan companies,” she says.

I would have liked to have asked the debt management industry exactly what it thinks it does for its fee, that the fee-free sector cannot, but unfortunately DEMSA, the debt managers trade association, didn't want to talk to me. Sigh….

So in the absence of the DEMSA promoting their industry, I shall have to declare the fee-free sector the clear winner by no contest. Don't touch the fee-chargers with a bargepole.

•  Even free debt management plans have drawbacks. Because you are paying back a lower monthly amount, your debt will last longer, and unless interest is frozen, ultimately be more expensive.

•  Creditors don't have to agree to repayment schedules, and may still try to pursue you through the courts. If the arrangement is reasonable, however, they will usually agree.

•  The plans may not be suitable at all for those people who have large debts and only a tiny amount left after their essential outgoings each month. They may have to consider bankruptcy. All the fee-free debt advice organisations should be able to recommend an insolvency practitioner. Insolvencies are at their highest levels since the sixties

Source: Payplan

NB - these are only examples. There is a risk some creditors will continue to charge interest, which may extend the repayment period.