What is debt consolidation?

Are bills piling up? Not enough money to pay all the bills that are coming in?  There are a few options.  Increase your income or decrease your expenses.  Doing both together is the best way to get out of debt.  Debt consolidation is another option for some as well as bankruptcy.  Being informed is vitally important in these last two options.

The borrower exchanges several smaller debts with different due dates and different interest rates for a single large loan and one monthly payment coming due on one single date each month with one interest rate.

This new monthly payment is usually lower in amount than the combined payments of the many smaller original debts put together.  It is smaller because the new payment is extended over a longer time frame.

WHAT DEBTS ARE USUALLY CONSOLIDATED INTO ONE?

  • Credit cards
  • Personal loans on furniture, luxury items, vacations, etc.
  • Auto loans (this is secured debt – or a debt held by collateral)
  • Student loans – several different student loans combined into one, or into another loan

THE CASE FOR CONSOLIDATION:

1. Borrowers can take several different credit cards and transfer (or consolidate) amounts onto one card with a lower interest rate.  Other options are to consolidate debts into a home mortgage because the interest rate on the mortgage (usually around 3-5% these days) is lower than the interest on the credit cards (averaging 12-20%).  Another advantage is that mortgage interest is also tax-deductible.  Also, borrowers also like the convenience of making fewer payments.

2. Perhaps the best way to go about debt consolidation is to obtain a consolidation loan from a bank and make on-time payments until the loan is paid off. The positive effects of this are that all of your debt is paid off and you have built a positive line of credit with the loan that you took.

Sounds like a good way to get out of debt?  Keep reading, there are several risks of debt consolidation.

THE CASE AGAINST CONSOLIDATION:

  1. When borrowers consolidate non-collateral debts such as credit card or personal loan debt into a mortgage or car debt that has collateral for a loan, they convert unsecured debt into secured debt. This means that borrowers who encounter financial distress and fail to pay their secured (collateral) debts not only lose their good credit but they also could lose their home or vehicle.
  2. Also, if combining all your debts into one home mortgage debt causes the mortgage amount to exceed what the property is worth, borrowers may also lose a chance to sell their home if ever needed.  Sale of the property requires that all mortgages be repaid, which means that the seller must come up with enough cash to cover the deficiency. Borrowers in this situation may also have to pass on opportunities for profitable refinance, since it is very difficult to refinance when debt exceeds value.
  3. Another risk is that moving credit card debt to the mortgage debt leaves credit cards open again.  Without the correct discipline not to use the credit cards and get serious about paying down their mortgage, a borrower can easily build up that credit card debt all over again. This could result in so much debt from mortgage AND credit cards that they never get out from under it—risking missed payments, foreclosure and possible bankruptcy.
  4. If you consolidate your debt on a 0% interest rate credit card and are unable to pay it, you will not only have negative markings on your credit report and a lowered credit score, but your 0% credit card can turn into a 29% interest rate if you make a late payment as well as a $29-35 late fee.
  5. Keep in mind that when you consolidate your smaller loans or credit cards into one, you lose negotiating power if you ever fall behind.  Keeping the original lenders of credit cards or personal loans, gives you the ability to call the lender directly to arrange repayment schedules or negotiate a lower interest rate.  When you consolidate your loan, you lose the option to work out payment plans that original lenders may be more apt to grant—especially if it is concerning student loans.

So it is important to know the penalties ahead of time and decide if it is worth it.

If you find yourself in severe financial difficulties or possible foreclosure, consult a non-profit credit counseling center or a Utah bankruptcy attorney to find the best options for your particular financial situation.