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, says the OFT.

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 recently.

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 study included a consumer survey, an analysis of complaints, and a review of advertising and marketing material for products that 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.

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.”

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 that 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.