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I wrote about some of the benefits of debt consolidation loans yesterday and promised the follow up on some the reasons why you should think carefully before taking out a secured loan to resolve debt problems. Well here it is!

A quick recap. A debt consolidation loan is a single loan, mostly secured against your home, that replaces unsecured loans such as credit and store cards which charge high interest with one loan with lower interest charges because you are house as security. Total interest charges are less and you can use the loan to pay of all debts and get your life and finances back on track.

It sounds a good idea, and for some it is.

Here are a few things to think about though.

Firstly, you still owe the same amount of money with a debt consolidation loan. Yes, the loan can resolve overdraft situations and their associated costs, and save you money on interest rate charges, but at the end of the day, you are still in debt by the same amount.

Also a secured loan is often taken out over ten years or more, so even though the monthly payments are less, you can actually pay more total interest over the term of the loan.

By taking out a debt consolidation loan which is secured against your property, you now own less of your house. Imagine counting all the bricks in your house and then taking some away, because that it what you have given to the lender when you secure a loan against your house.

A debt consolidation can help debt problems but it can’t cure them. This is an important point. If you overspend on your credit cards because you don’t want to wait to pay for nice things by cash then you have to be careful that you don’t continue with that course of action when a debt consolidation loan clears all your credit cards. If you continue to max out credit cards then not only are you in debt again, but that debt is on top of the consolidation loan debt.

You must change the way you borrow money when debts have been cleared by a consolidation loan. The ideal situation is to clear your credit cards and then cut them up!

For those who can modify their spending behaviours, but have encountered unusal circumstances that have created debt problems, a debt consolidation loan can be the ideal solution to get back on your feet again, remebering that your house is at risk if you fail to meet loan repayments.

However for those with no self control when it comes to spending and borrowing, a debt consolidation loan can drive them deeper into debt difficulties and may result in debt management programs, an IVA or even bankruptcy.

Working in the finance industry I see at first hand the reasons why people want to borrow money, particularly if it is not for arranging mortgages for property purchases.

It’s striking to see that debt consolidation is the most frequent reason that people arrange secured loans - in which they use the equity in their homes as security against a larger loan. Around 60 percent of home loans are for debt consolidation reasons.

There are good reasons for taking out a debt consolidation loan - and also strong reasons why they are not a good idea, which I’ll explain in my next post - and this is why so many people rely on them to bring their finances back onto an even keel.

Many types of unsecured debts attract high interest rates and credit cards can top the league in interest rate charges. APR’s of 20% or more is common. Store cards and store based finance can be bad too. Argos, for example, charge a typical APR of 27.9%. This means that each year you are paying almost a third of your purchase cost in interest charges.

So if you are “maxing out” several credit cards and have a store card or store based finance, you are paying huge amounts in interest charges. if the interest charges start to hurt then it’s easy to become overdrawn and your bank starts geting in on the action by charging you all those unauthorised overdraft fees and associated costs.

In this situation, debts mount and life becomes difficult.

As a secured loan allocates the equity in your house as security, home loan lenders can charge less interest as their risk is reduced - although you risk losing your home if you don’t keep up with loan payments. So a secured loan often costs less than all those credit and store cards.

So by borrowing an amount against your house, you can repay all those credit and store cards and stop the bank form charging exorbitant fees as you put money into your bank account to get it in the black again. Your overall monthly loan payments will be less and you can start to turn your finances around.

It is for these reasons that debt consolidation loans offer an attractive proposition and that is why so many people take them out. There are down sides, though which I’ll explore in my next post.

Changes are afoot in the loans industry at the moment. The credit crunch and recent difficulties experienced by Northern Rock is starting to have an effect.

I’m hearing rumours that two lenders are withdrawing from the loans market altogther. I can’t say which ones at the moment as I’m not sure if they have announced the situation. Both are “off balance sheet” which means that they work in the same way as Northern Rock - they borrow money at one rate and then lend it at a higher rate.

We’ve seen the impact that this business model has on Northern Rock (whose shares are still in the doldrums). The financial institutions behind these two lenders are US based and have sustained heavy losses in the credit crisis.

So two mainly sub prime lenders are exiting from the UK loans market.

But that isn’t all. Mortgages PLC are not going to lend to “heavy adverse” applicants any more and are reducing the acceptable loan to values of their other sub prime mortgage products. Even their near prime and self certification mortgages will have their maximum LTV’s reduced from 90 percent to 85 percent.

I mentioned a few days ago that the Northern Rock crisis will affect many more people than just its customers.

We’re seeing the start of a tightening of lending criteria. Those with impaired credit histories are going to find it harder to borrow and are going to have to borrow less.