Debt Consolidation

Where a borrower is consolidating its debts, the FCA is considering introducing a requirement for lenders to either take reasonable steps to ensure that these debts are repaid as expected or include these debts as part of an affordability assessment.

As shown in the figure below, almost all survey respondents told us that they already made payments directly to other creditors in either all or some cases when a borrower was taking out a second charge loan to consolidate existing debts. However, the FCA’s proposal does not necessarily require that lenders make payments directly to creditors themselves. For example, providing the borrower with a cheque payable to their creditor would be one way of meeting this requirement. Figure 31: Proportion of respondent currently making payments directly to the other creditors where a borrower is taking out a second charge loan to consolidate their debts

Costs

Lenders reported that secured loans are always paid off directly because they have to clear the charge before creating their new charge. However, where the borrower is consolidating unsecured credit, the processes followed by lenders differed. Whilst the large majority of firms indicated, in the 50 _{This estimate is largely driven by an estimate of £120,000 from a broker to comply with this requirement. If this estimate} was excluded this figure would fall to less than £0.1 million. We also not that the Oxera report for the FSA assessing the costs of complying with the MMR assumed the costs of a stress test would likely be low as most lenders’ existing affordability

50% 42% 8% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% No

Yes in some cases Yes in all cases Don't know

survey, that they paid creditors directly, in our interviews with them, only one lender reported that it paid the unsecured debts directly. Most paid by cheque to the customer made payable to the creditors. According to the lenders, this ensures that the funds can only go to the creditor, but the burden of administration in terms of naming the creditors lies with the borrower.

A minority of lenders indicated that they left the consolidated unsecured debt payments for the borrower to arrange.

However, one major lender reported that it has already started paying directly by BACS to the borrowers’ creditors, only sending cheques (again directly to the creditor) where it is not possible to do so. The lender stated that only one

or two extra staff were required to make the shift to BACS. But given that under the proposed regulations payments would not need to be made direct to other creditors (e.g. a cheque could be written out to the creditor and sent to the client), other lenders might not have to incur the costs of moving to BACS system.

The majority of firms we interviewed and those who responded to the survey provided details of the impacts, and potential costs, on the basis of making payments directly to creditors (which the FCA is not proposing). If payments were to be made direct, one firm estimated an extra cost of £100,000 per year based on two to three extra staff members, not including any further overheads. One lender estimated an overall one-off cost of £250,000 to meet this requirement, however they did not break down the overall cost estimate in to the sub sections in Figure 32 below.

Additionally, if payments were to be made directly, it was highlighted that brokers would incur costs in having to collect more information during the sales process. Whilst one broker explained that it already collects information on creditors from the prospective borrower as part of its sales process and already issues a debt consolidation form that includes the majority of the information required, this appears to be a rare case and other brokers indicated that they do not have this system in place. One broker suggested that if payments had to be made directly it would lead to an increase in the sales process of 20 minutes per loan, whether the loan went on to be completed or not. Another broker suggested a 5-10% increase in case manager time per loan if it were to collect BACS account information.

The four responses to the quantitative survey questions in this area suggested that the one-off costs of arranging for direct debt consolidation payments are expected to be larger than the ongoing costs in totality. One lender expected costs of £20,000 for making changes to its IT system, developing new sales processes, HR/training costs, cots of appointing additional legal and compliance staff and costs of appointing additional sales staff. The same lender also expected a particularly high ongoing cost of spending additional time processing each loan. However, as noted above, the proposed regulations would not require direct payments, therefore lenders and brokers would not be required to incur these costs. Only the firms who do not currently provide borrowers with cheques payable to their creditors would have to change their practices and so incur costs. These would likely be considerably lower than those estimated below.

“Already done. For unsecured we issue the funds payable to the creditor - cheques to the customer. If you are consolidating 10 creditors how would we know we are sending it to the right place. But if we send it to the customer we know they are sending it to the right place.”

Figure 32: Response to quantitative questionnaire: Impact of arranging for direct debt consolidation payments to creditors

One-off Ongoing

£s Min Max Average Non-zero answer Min Max Average Non-zero answer

Cost to set up a new IT system - - - - - - - - Cost of making changes to your existing IT system 20,000 20,000 20,000 1 - - - - Cost of developing new sales processes 2,000 20,000 11,000 2 1,000 1,000 1,000 1 HR/Training costs 2,000 20,000 11,000 2 1,000 1,000 1,000 1 Cost of spending additional time processing each loan 1,000 20,000 10,500 2 1,000 30,000 15,500 2 Cost of appointing additional legal and compliance staff 20,000 20,000 20,000 1 - - - - Cost of appointing additional sales staff 20,000 20,000 20,000 1 - - - - Other 30,000 30,000 30,000 1 - - - - Benefits

The proposed regulations would not require direct payments to creditors. Although most firms indicated that they already meet the FCA’s proposed requirements by providing borrowers with cheques payable to their creditors, hardwiring current practice into rules would help ensure that benefits are realised consistently. Only those customers taking loans from lenders who do not already adopt these practices would benefit.

For these customers, the proposals would benefit them in that there will be an immediate payment of their other debts and it will decrease the burden on the borrower to organise his/her debt consolidation. Ensuring that the money is put towards debt repayments removes the risk that borrowers may use the money intended for debt consolidation for other (non-essential) expenditure, counteracting behavioural biases that might see customers making poor choices. Where a customer is in arrears on the debts being consolidated into the second charge loan, this could reduce any additional arrears charges faced.

Those limited number of consumers interviewed who had taken out loans for debt consolidation purposes indicated that they received the money directly into their account. Most were happy with this, stating that they preferred to have “control”. They reported that they had paid the money off within a month - either making calls straight away or waiting until the next bill came in - and had therefore incurred minimal interest on their pre-existing debts. On this, albeit unrepresentative, sample of views, the benefits of the proposed regulations to require direct payment of creditors may be limited. However, there may be a case to suggest that those accruing large debts and unable to manage their finances would benefit from this policy.