Clients need a tailored solution
Consolidating debt may seem simple but there’s a lot more at play then there first appears.
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% per annum then it’s a no brainer to simply refinance this into their home loan, right?
Well, not exactly.
Consider that $30,000 at 15% p.a. 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 may have dropped their repayments but you’ve also 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.
If you’re consolidating debt, you should set it up as a separate loan account and try to limit the term on this account to around 5 years.
Ask yourself: “What’s more important? A lower repayment or saving 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’re 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. Other types of debt pale in comparison.
When you compare a credit card to a car loan or a personal loan, you’ll find that:
- They tend to have higher interest rates.
- Most customers don’t even try to pay them off.
- The minimum payments of around 3% per month drop as the balance drops so they have a long term.
- Interest free periods have hidden catches which mean customers usually end up paying interest on them.
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.
As a general rule, you should consolidate debts in the following order of priority:
- Credit cards
- Personal loans with small balances
- Large personal loans
Credit cards are the most expensive and the most likely to result in your 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 (balloon payments) as it’s near the end of its term.
So you can have a big impact on the customer’s cashflow by consolidating this debt under lower home loan rate.
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’d 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?
Typically, large amounts of unsecured debt is a symptom of another disease, metaphorically speaking.
If you treat the symptoms without treating the real problem then your customer will 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, they’re almost guaranteed to get into the same situation again.
Did the cards get closed?
When a debt consolidation loan settles, the credit cards still remain 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 mortgage 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 your client’s home loan is paid on time, they can still get a sharp rate.
You should talk to customers about the weekly difference in repayments compared to going to a mainstream lender.
But perhaps more importantly, really paint picture for the client that going with a specialist lender is 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 often take action too late
In many instances, a customer will call you when they’re well behind on all of their debts and even have a few defaults under their belt.
The problem with this is that 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.
To combat this, you should look at your arrears in your commission statement in Mercury each month and call customers before their debts become a bigger problem.
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