Debt consolidation is another popular approach to managing a burdensome debt load. When most people use the term "debt consolidation," they mean one thing. But most of the services out there that offer debt consolidation mean something entirely different.
Here's a simple multiple choice question for you to answer:
a) Borrowing enough money from a bank or finance company
to pay off all your bills at one time, leaving you with a lower interest
rate and a single lower monthly payment.
b) Borrowing against the equity in your home to pay off credit cards and
other unsecured debts.
c) A service offered by non-profit organizations called Consumer Credit
Counseling Services, who work with your creditors to lower your interest
rates and help establish a repayment budget.
d) Bankruptcy under the Chapter 13 procedure.
e) All of the above.
f ) None of the above.
What is your answer? The chances are, you picked (a), because that is what most people think of as true debt consolidation. However, the correct answer is (e) "all of the above." Let's take each one of these variations on debt consolidation in turn.
a) BORROWING - For example let's say you owe $25,000 in credit card debts. It will 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 less than 9 years using a lower monthly payment. Sounds better, right?
There's a problem. Who is going to lend you $25,000 without collateral (like a house or other property)? In today's world, few people who do "consolidate" are accomplishing what we have just described. Especially if you are having any type of financial trouble.
b) EQUITY - 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 default, they 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. If you are a disciplined person financially, and your hardship situation was temporary, you may emerge from the scenario with your credit intact. 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 with new offers for credit cards coming in everyday in the mail. Then they find themselves holidays shopping, or they just have to buy that awesome new home theater system for $2,500. Before they know it, they owe $10,000, $15,000, or even $20,000 again in credit cards, PLUS they have the second mortgage to keep up. The result is disaster.
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 pay them. 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 do this year after year.
c) CREDIT COUNSELING - 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 Consumer Credit Counseling 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 temporarily. You make one monthly payment to the counseling 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, and in the financial world Credit Counseling is the cure-all for debtors who are in over their heads.
Does CCC really work? That really depending on your situation. You have to understand that the counseling service, while in theory a non-profit organization, actually receives compensation from the bank you owe the money to. So, whose side are they really on - the side of the consumer who's paying a monthly $20 administrative fee, or the bank that's paying 7% of the restructured debt?
With a CCC program, the most frequent complaint from ex-participants is that they have little knowledge of what the CCC agency is doing on their behalf, and they have virtually no control over the process. They send in their single monthly payment, with no idea of how much is going to which creditor, and since most counselors are busy people who work based on high volume, getting a return phone call can be difficult A new and growing problem is the CCC companies are paying the creditors late, or not at all!
d) CHAPTER 13 - The final form of "debt consolidation" is actually not consolidation at all, but rather a form of bankruptcy called "Chapter 13." Be very careful, many of the ads you'll see for "debt relief" or "debt consolidation" are really attorneys advertising to take you through a formal declaration of bankruptcy. So watch out!
We offer a Debt Settlement or Debt Negotiation Service that might be right for you, please e-mail us or call the office to speak to someone about your personal needs.