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The Truth About Debt Consolidation

Debt consolidation is a popular approach to managing a burdensome debt load. When most people use the term “debt consolidation,” they mean one thing. But really there are 3 debt relief services or programs that market themselves under the consolidation umbrella.

BORROWING

Say you owe $25,000 in credit card debts. It may take you up to 25 years to pay off those debts with minimum payments, depending on how the bank handles the interest calculations.

If you go to a finance company instead, and borrow $25,000 at 12% interest, with a $400 minimum monthly payment, you’ll have the loan paid off in less than 9 years using a lower monthly payment. Sounds better, right?

There’s a problem, though. Who’s going to lend you $25,000 without collateral (like a house or other property)? Very few people who are in financial trouble have the credit history necessary to borrow enough money to pay off their debts. This is only logical since if you are looking for debt relief, you are probably late on payments, or have had a spotty payment history. This will make it very difficult for you to obtain an unsecured loan.

If you have a high credit score, stable income and can obtain a low interest loan then this may be a viable solution for you. However, you have to be honest with yourself and realize that you need to change your habits that have caused this fincancial situation otherwise you will be doomed to repeat it.

EQUITY LOANS

Another variation on “debt consolidation” is based on your ownership of real estate. If your home is worth more than you paid for it, you have equity, and many banks will gladly lend you money against it (assuming your credit report looks good enough). There is little risk to the lender, because if you dont pay back the loan, you default, and the lender can force a foreclosure on your property to recover their money.

So, let’s say you have $25,000 equity in your house, and you find a bank willing to loan you $25,000 with your house as collateral. This is the ever-popular “second mortgage” or “equity line of credit.” You then pay off your credit cards. At this point in the program, things can go well or not so well. If you are a very disciplined person financially, and your hardship situation was temporary, you may emerge from the scenario with your credit intact and bills paid. You still have the same level of overall debt, but it is structured in a way that you can live with.

Many people, however, find that they end up in worse shape using this approach. Why? Because they suddenly have $25,000 worth of credit available to them, but they don't have the financial disipline not to spend it on unessecary items. The new car, home remodel, vacation.... look at the Jones' they know. A year goes by and the $25,000 is spent and they find themselves going back to using the credit cards. After a couple years the credit cards are maxed and they are faced with overwheliming debt, but now no equity in their home to help pay it off.

There’s also another big problem with borrowing against your equity. You trade an unsecured debt for a secured debt. If you default on a credit card balance, the creditor (if you ignore the problem long enough) can sue you and obtain a court judgment. Then they can put a lien against your house, so that if you ever sell the house, you’re forced to hand over the money. But they cannot force the sale of your house. A secured debt is a far more serious matter, because you’ve pledged your house as collateral. If you default on a debt that has been secured by your house, then you risk losing that home.

Why trade unsecured debts for secured debts? For most people, this is not the best move to make. Yet countless individuals fall for this trap year after year.

DEBT MANAGEMENT PLANS

The third variation on “debt consolidation” is not really consolidation at all in the true sense of the word, as described above. Instead, you are enrolled into a debt repayment program. You meet with a counselor who analyzes your monthly budget. The counselor then makes contact with your creditors and attempts to get them to lower the interest rate. You make one monthly payment to the agency, which then disburses the funds to your various creditors.

The theory here is that your overall payment per month is lower due to the counselor’s success at obtaining lower interest rates and more favorable terms with the credit card banks. This approach is the one most often recommended by the banks themselves as the cure-all for debtors who are in over their heads. The reason is simple, your monthly payment is lower, not just because of lower interest rates, it's lower because they have stretched your repayment terms out over many years. Ultimately, you pay less each month, but at the end of the program you have paid more for the debt. The counselor made more money and so did the creditors. You should also carefully consider the debt relief companies motives, if they are compensated by your creditors, and they only make money if you continue to be in their program, what is their motivation for you to become debt free?

If you are having a financial hardship, such as loss of income, medical, divorce etc., are late on making payments to your creditors, and are considering bankruptcy we may have an alternative. It is called debt negotiation. We evaluate your financial situation and understand your hardship. Once the creditor agrees to a reduced payoff you approve it and they are paid and the debt is gone. This process takes anywhere from 24-36 months and depends on your exact situation. Our program is not a way to avoid paying debts that you can honestly afford to pay. If you have the ability to pay your creditors then by all means this is what you should do. If you can't pay and you are considering bankruptcy contact us today and let us see if you can qualify for our program. Submit a free no obligation request here.