Midweek Money: The Fixers - How to get out of a debt trap

TWO SISTERS came to me for advice on how best to manage their loans. They had a property with a reasonable amount of equity in it. But they had a number of debts on credit cards, and a bank overdraft amounting to pounds 10,000. They were paying a monthly amount of pounds 400-plus, which they were finding excessive.

Their situation was not helped by the fact that both were underpaid for their jobs. One sister was actively looking for another job; the other was happy where she was.

Looking at the loans that they had was an interesting exercise. Their bank had lent them some money on overdraft and had refused to lend it in any other way. This meant that they had the loan at the most expensive rate that the bank could possibly charge them.

It does seem to me to be irresponsible of lending institutions to lend on a basis that compounds the problem. Setting aside the moral issue, financial prudence would dictate that they should attempt to get their clients out of debt as quickly as possible.

I do understand that banks have to cover the cost for the reasonable risk that they take. However, bearing in mind that there was sufficient equity in the property, the bank could have secured their loan so as to reduce the risk. This would have given the sisters a much better rate of interest and more comfortable repayments. Admittedly it would have involved more paperwork and a degree of hassle; but the option was not even explored.

Anyone looking to consolidate debts on credit cards should note that several credit card institutions are offering special rates for a short period of time. It is therefore possible for individuals to play "credit card leapfrog" and move from one credit card company to the other, if that saves money - although some companies will tie you in for up to a year after the cheap rate has expired.

The first step, if you have a debt, is to take stock of the situation. There are several remedies. First, the cheapest way of borrowing is nearly always by first mortgage on your property. As the sisters had equity in their property this was the suggestion that I made to them. By spreading the loan over a longer period of time and dropping the interest rates by two-thirds, they reduced their monthly outgoings to pounds 90.

If their building society will not look on them favourably, they have other avenues. They can try other credit card companies, who may charge less. They will have to make sure that the credit card company realises that they will be repaying their old debts, not adding to their indebtedness.

Another solution is to look at putting a second charge on the property, possibly via a bank loan. This would have the advantage of reducing the amount of interest and spreading the payments over a longer period of time.

The psychology of debt is interesting. Somehow anyone who borrows money feels that the institution making the loan is doing them a great favour. I think it was Bob Hope who said something to the effect that "banks will lend me money only if I can prove to them that I don't need to borrow it".

Anyone in debt should remember that the money is being lent to them at a commercial rate, and that the lending institution is making a fair return on their "investment". Just a look at the annual rate of interest will show who is doing better out of the arrangement.

When restructuring debt, the important thing is to make sure that the restructuring is manageable. If it is simply perpetuating the downward spiral, there is not much point to it. Do so with the view that you are going to pay it off by a certain period of time.

When you have repaid the debt, make sure you put the money with which you have been servicing the debts into savings, so that you build up some money and avoid having to borrow in the future.

This type of work does not fall within the normal remit of an independent financial adviser. For those who advocate paying fees for advice, I wonder how they consider an IFA should be paid in this case. Any fee that I would have charged for the advice I gave would simply have put the sisters further into debt. Yet morally they are surely as entitled to advice as anyone else.

The key question is, who pays for this advice? Should other clients subsidise couples like them? It is not something that many people are prepared to do. Should the adviser work additional hours? That is not sustainable in the long term.

I find this circle difficult to square. It is often those in most need of advice who can least afford to pay for it.

Amanda Davidson is a partner at Holden Meehan independent financial advisers in London (0171-692 1700)