More Truth About Debt Consolidation
 

BORROWING

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, though. Who’s going to lend you $25,000 without collateral (like a house or other property)? In the real world, few people who do “consolidate” are accomplishing what we’ve described here. Very few people who are in financial trouble have access to the credit necessary to borrow the lump sum in the first place. If you’re behind on your payments, expect that to show up on your credit file, and therefore expect to get turned down by every loan officer in town.

If you’re still current on your payments, you might pull this off, but it’s still unlikely that you’ll be able to borrow enough to solve the problem. (Many people simply add to their debt this way, by obtaining another line of credit, which then becomes part of the original problem.)

This is also where the scam operators flourish. Desperate consumers respond to advertisements for “guaranteed loans.” The ads state “no credit check required” and offers attractive terms. BEWARE: These are usually variations on the “Advance Fee Loan Scam.” The catch is that the operator on the other end of the telephone asks for a payment up front in order to process the application, anywhere from $25 to $300 or more. You send the money and never hear about the loan, or you are turned down for the loan. People in financial difficulty are usually too broke to hire an attorney to chase the scam artist who ripped them off, or they’re simply too embarrassed to go after them. Don’t fall for this con game. If you’re going to borrow money, do it in your hometown, where you can look the lender in the eye!

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. 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. 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 the daily mail. Then they get busy planning for the holidays, or they just have to buy that awesome home theater system for $3,500. Before they know it, they owe $10,000, $15,000, or even $25,000 again on those pesky credit cards, PLUS they have the second mortgage to keep up. The result is disaster.

If you plan to use this consolidation opition, make sure that you are committed to your debt-elimination plan. If you are not committed, this debt consolidation method is just another trap that many people fall into.  DFS can help you determine if this is the right option for you and even help you accomplish it so that the consolidation plan works hand in hand with your debt-elimination plan.  Take a look at the DFS Advantage to discover all of the benefits that DFS can offer you! Also be sure to check out the Mortgage Resource Center as well!

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 cardbanks. This approach is the one most often recommended by the banks themselves, and in the financial press these debt repayment plans (through “non-profit” agencies) is touted as the cure-all for debtors who are in over their heads. So, does this really work? Well, maybe yes, more likely no, depending on your situation. More than half of all who enroll in such programs drop out before finishing the plan.

Read "The Truth About Non-profit Debt-Management Companies" for the warnings to watch out for if concidering this type of program. The final word is... this type of program usually doesn't offer enough real benfits or relief that most people need that are in a crisis situation.

CHAPTER 13 BANKRUPTCY

CHAPTER 13—The final form of “debt consolidation” is actually not consolidation at all, but rather a form of bankruptcy called “Chapter 13.” For more detailed information about this plan. visit the Credit Resource Center under the bankruptcy heading. Be forewarned, however, that many of the ads you’ll see for “debt consolidation” are really attorneys advertising to take you through a formal declaration of bankruptcy. Watch out!