A debt consolidation loan replaces several existing debts, which might include a cash advance, credit cards or other borrowing, with a single new loan, usually to simplify repayments or reduce the overall interest rate. Whether it is a good option depends heavily on whether the new loan is secured or unsecured, and on the same affordability assessment that applies to any other regulated credit agreement.
The affordability check that still applies
A debt consolidation loan is, for regulatory purposes, a regulated credit agreement like any other, so the FCA’s creditworthiness rules apply before a firm can lend. CONC 5.2A requires a firm to undertake a reasonable assessment of a customer’s creditworthiness before entering into a regulated credit agreement, considering both the risk that the customer will not make repayments and the risk that repayment will cause the customer undue difficulty, described in the rule as affordability risk. The firm must assess whether the customer can repay in a sustainable manner, without having to borrow further, without missing other payments, and without the repayments having a significant adverse effect on the customer’s financial situation.
What the assessment is based on
CONC 5.2A requires this assessment to be based on sufficient information, which can include the customer’s income, verified where appropriate by evidence, and non-discretionary expenditure such as essential living costs and existing priority debts, along with any reasonably foreseeable reduction in income or increase in expenditure over the term of the agreement. Because a debt consolidation loan is specifically being taken out to deal with existing debt, a lender assessing affordability should, in principle, already be looking closely at exactly the kind of existing commitments the loan is meant to replace, not just at income in isolation.
Security cannot be used to justify the lending
One safeguard in the FCA’s rules is particularly relevant to debt consolidation. CONC 5.2A states that a firm must not take into account the existence of, or an intention to provide, a guarantee, indemnity or other form of security when assessing the affordability risk for the customer. In other words, a lender cannot approve a loan it would otherwise consider unaffordable simply because the loan is secured against the borrower’s home; the underlying ability to repay still has to stand on its own.
Unsecured consolidation vs a secured homeowner loan
A debt consolidation loan can be unsecured, in which case it is regulated in broadly the same way as a cash advance under CONC, or it can be secured against the borrower’s home as a second charge loan, in which case it falls instead under MCOB, the FCA’s mortgage conduct rules, as covered elsewhere on this site. Converting unsecured debts, where the ultimate consequence of non-payment does not include losing a home, into a single loan secured against the home changes the nature of the risk considerably, even where the monthly repayment looks lower. This is the central trade-off anyone considering consolidating debt through a secured loan needs to weigh, separately from the headline interest rate.
Why the total cost matters more than the monthly figure
A debt consolidation loan can lower the monthly outgoing simply by extending the repayment term, even where the interest rate is similar to or only slightly better than the debts being replaced. A longer term can mean paying more in total interest over the life of the loan than would have been paid on the original debts, despite the smaller monthly amount. Because the FCA’s affordability assessment looks at whether repayments are sustainable rather than at whether the total cost is minimised, a borrower comparing consolidation options needs to check the total repayable figure specifically, not rely on the lender’s assessment alone to identify the cheaper option.
Before applying
Listing every existing debt, its balance, interest rate and remaining term, makes it possible to compare a consolidation offer properly against simply continuing with the existing debts, or against other options such as those covered elsewhere on this site, including debt management plans. A new consolidation loan also generally involves a fresh credit search, and an existing debt that already has good terms, such as a low promotional rate that has not yet ended, is not automatically improved by rolling it into a new loan.
FAQs
Does a lender have to check affordability before approving a consolidation loan?
Yes. CONC 5.2A requires a reasonable creditworthiness assessment, covering both credit risk and affordability risk, before any regulated credit agreement, including a consolidation loan, is entered into.
Can a lender approve a loan it would otherwise see as unaffordable just because it is secured?
No. CONC 5.2A specifically states that a firm must not take a guarantee, indemnity or other security into account when assessing affordability risk.
Is a debt consolidation loan always unsecured?
No. It can be unsecured, regulated under CONC, or secured against the home as a second charge loan, regulated under MCOB, and the two carry very different risks if repayments are missed.
Does a lower monthly payment always mean a consolidation loan is cheaper overall?
Not necessarily. A longer term can reduce the monthly payment while increasing the total interest paid over the life of the loan.
Bottom line
A debt consolidation loan is subject to the same FCA affordability assessment as any other regulated credit agreement, and a lender is not allowed to rely on security alone to justify lending that would otherwise look unaffordable. The more significant choice is usually between an unsecured consolidation loan and one secured against the home, since the second converts unsecured risk into a risk that can ultimately affect where the borrower lives. This article is general information, not financial advice on a specific loan; a free debt adviser can help compare consolidation against other options for a specific set of debts.