According to the latest reports from the financial sector, more than 80% of Americans currently carry more than $137,000 in debt. In most cases, these ongoing financial obligations are scattered across several different monthly payments. Unfortunately, this is often where the true problems begin for our nation’s households.
Having numerous outlays can become an issue, but many find relief in the form of debt consolidation. While this debt relief option was developed with consumers’ needs in mind, many fall victim to unscrupulous business practices when seeking help from outside sources. While laws have been put into play to safeguard Americans in need of relief from overbearing debt, many consumers are unaware of their rights and protective provisions in this regard.
What’s Debt Consolidation?
Debt consolidation is actually a simple concept. You tally up your total debt and take out a loan large enough to cover it all. This loan is used to pay off all those separate financial commitments, leaving you with a single payment to worry about each month rather than numerous ones.
While it’s an effective way out from under crushing debt for some, it can cause even greater issues if not pursued and carried out in the right way. Unfair and even illegal practices on the part of debt management companies only serve to exacerbate the problem. We’ll discuss these aspects in further detail shortly, but first, let’s delve deeper into the overall concept of debt and resolving it via consolidation.
Breaking Down the Issue
For the most part, American families bear a diversity of debts. Mortgages and auto loans are among the most common, with credit cards and student loans following closely on their heels. Personal loans fall not far behind along with store charge accounts and medical bills. While some household debts fall outside the norm, these are the most frequently occurring ones.
Understanding the Underlying Problems of Debt
Since expenses have been on a steady upward trend over the last several years, and average household income has all but flat-lined, reliance upon credit cards and loans has soared. Although creditors are cashing in on this uptick, they’re also faced with increased risks when lending to the public.
Many have made overzealous attempts to shield themselves from potential losses, and done so at the expense of borrowers. Regulations protect creditors’ interests when it comes to collecting on debtors’ obligations, but their entitlements only go so far. Most consumers aren’t fully aware of where the line is drawn, and this is where one of the most significant issues begins to take shape.
On the most basic level, multiple monthly payments can be a bit difficult to keep up with even for those who have a firm grasp on the fine arts of organization and money management. Overlooking even a single bill for only a month can lead to exorbitant late fees, accruing interest, and declining credit scores, to name a few concerns. Those, in turn, bring about hardships when the time comes to make up for that inadvertent oversight; it then becomes a vicious cycle.
Lenders typically exhibit a certain level of understanding when debtors run a bit late on their monthly payments or miss one altogether, but their sympathies tend to be shallow. Beneath the surface, creditors actually profit from past due payments by way of late charges, accruing interest, and other fees. Each state has specific policies in place limiting the amount creditors are allowed to charge in past-due penalties, but these laws are difficult to regulate and enforce.
Upping the Ante
As if unfair penalties and fees weren’t enough, consumers are also contending with interest rates. Credit cards are notorious offenders in this regard. Earlier this year, average interest rates on credit cards surged past 16% based on industry-wide reports, and the numbers are expected to continue on an upward trend for the foreseeable future.
At this point, no caps have been assigned to credit card interest rates, so they’re fair game for issuers. Some charge as much as 30%, and a few have pushed the envelope even further. Typical American households have more than $6,000 in credit card debt as of now, a figure also predicted to swell during the years to come. At this amount with 30% interest to boot, a single credit card could easily drive a family to the brink of financial breakdown.
Gauging the Impact
Using the industry average as an example, take a look at how much the standard going rate would actually cost you over time. With a credit card balance of $6,000 at 16% interest, a typical minimum required payment of 2% of the balance would run you $120 per month. At just the bare minimum, paying off this credit card would take you more than 32 years. During that time, you’d pay almost $11,000 in interest alone. Bump the interest rate up to 30% and you could make minimum payments for the rest of your life without ever paying off this credit card.
Interest rates, rather than difficulties with keeping track, are the biggest hurdles most people face when dealing with numerous monthly payments. In the case of our example average credit card interest rate and debt, only $40 per month is going toward the principal balance; interest eats up the remainder. Although rates are typically lower for most auto, home, and personal loans, as well as medical expenses and other accounts, the principle remains much the same.
Bringing It All Together
With debt consolidation, you stand to save quite a bit of money under the right terms and conditions. Dropping a single point on the example credit card interest rate, while keeping payments the same each month, would shave about $2,000 off your total amount paid and reduce the projected payoff by about two years. Obviously, you wouldn’t take out a consolidation loan for a single credit card, but this is just an illustration of how a solution like this could help reduce your debt.
Debt consolidation loans were originally meant to provide relief from mounting financial liabilities courtesy of lower interest rates than the debts being combined. At one point, companies offering debt consolidation loans were required to keep their interest rates below 9%, but this restriction has since faded into oblivion. Some still extend lower rates to their borrowers out of courtesy, but they’re not currently required to. While proposed legislation could soon bring positive changes to the industry, no new laws have officially been passed to this end.
What to Look for When Considering Debt Consolidation Agencies
One of the world’s oldest sayings applies when it comes to debt consolidation offers or any other option for that matter: If it sounds too good to be true, it probably is. Some debt relief companies insist they can get you out of debt within a matter of months courtesy of a consolidation loan, but this is highly unlikely unless your amount owed is only a few hundred dollars.
If that’s the case, you probably don’t need a loan in the first place. Rearranging your budget to find extra money to contribute to those small outlays could easily fit the bill. It may be as simple as cutting back to basic cable or eating at home every night rather than frequenting your favorite restaurants. Lenders are prohibited from making untrue claims or offering false hope to potential borrowers, but many overlook this ban.
Don’t Pay in Advance
Additionally, be wary of debt management companies asking for advance payment for their services. Federal law prohibits these organizations from accepting upfront payment; instead, they’re required to build their fees into your monthly payments. They also aren’t allowed to demand payment until they’ve developed a viable approach to your debt and come to an agreement with your creditors.
Know the Details
Debt relief organizations are also obligated to provide absolute transparency regarding any extra charges you may face. Certain states place a cap on the fees these organizations are allowed to charge clients, and some have even banned for-profit debt management companies altogether. Look at the laws in your state before enlisting the services of an agency so you know your rights ahead of time.
Take a Stand Against Intimidation
Don’t let self-proclaimed debt management specialists bully you into accepting their services. You’re free to inquire about what they have to offer and not required to commit to any type of agreement. They’re under strict regulations against harassing you or trying to force you to take action, even if you made first contact.
Don’t Give Out Your Personal Information Prematurely
Just as you need to ask questions to understand what debt consolidation agencies have to offer, they’re representatives will need to inquire about your financial situation. This helps them provide accurate quotes or connect you with lenders who are able to cater to your specific needs. Still, they’re only entitled to certain details during the initial phase of interaction.
Never give out your bank account information, social security number, or other personal data while you’re carrying out comparison efforts. Offering up this information could be construed as consent for payment even if you expressly tell the company you’re not interested in its services. As mentioned, they’re not legally allowed to accept payment before achieving at least some level of results for you, but not all companies adhere to this statute. Consumers are defrauded of thousands of dollars every day because of this one simple example of trusting the wrong people too early on in the process.
Save Yourself from Undue Heartache
If you decide to seek professional intervention, be mindful of these aspects. Although many agencies of this nature operate on a not-for-profit basis and follow best business practices, some don’t exactly have your best interests at heart. Don’t let the latter take your money and run.
Look for agencies accredited by the National Foundation for Credit Counseling (NFCC), the Council on Accreditation (COA), and/or the International Organization for Standardization (ISO). These endorsements should be easily visible somewhere on their websites. Browse the Better Business Bureau for complaints against any company you’re considering as well.
Overall, there’s no harm in checking out all your options before deciding which one is best for you. Legitimate credit counselors and debt management agencies follow the rules and respect their potential clients, so if any aspect of their services or interactions seems to go against the grain, it’s best to look elsewhere for assistance.
What Else Do I Need to Know?
First off, not all of your debts can be included in a consolidation plan. Typically, only unsecured debts are eligible for consolidation. These are obligations not backed by collateral, such as:
- Personal loans
- Credit cards
- Store charge accounts
- Medical bills
- Student loans (can only be combined using loans designed specifically for consolidating student loans)
Through debt management agencies, past-due obligations may also be included in consolidation plans. Though this covers a lot of ground, it doesn’t encompass secured debts such as mortgages, auto loans, and personal loans for which collateral has been promised. Any company that tells you it can consolidate all your debts is making fraudulent claims and in violation of the law.
Secondly, debt relief organizations offering consolidation are required to follow very specific protocol. After you agree to take advantage of the company’s services, your debt management specialist must draw up a viable plan for combining your applicable debts, disclose to you all terms and conditions, and notify creditors of your plans.
At that point, you’ll begin making payments to an account dedicated solely to your consolidation efforts. You won’t be sending money directly to the debt consolidation agency; instead, the dedicated account must be established with an accredited financial institution. If there’s any indication the agency is intercepting your deposits, or they’re being sent to an unheard-of institution, stop sending payments and notify the proper authorities.
Along those same lines, the bank with which your consolidation account is held should not be affiliated with the debt management company in any way. It should be an unbiased institution. Some organizations receive kickbacks off each account directed to certain financial institutions in spite of being forbidden to accept commissions.
Don’t be shy about asking exactly where your money will be going before entering into an agreement with a debt management agency. You have the right to know, and if it’s following best business practices, the organization won’t hesitate to provide an answer.
One Additional Piece of Advice
Credit counseling and debt management agencies can be effective tools for those interested in debt consolidation, as long as they’re running a legitimate operation and truly striving to serve their clients. Though they’re at your disposal, you don’t necessarily need professional intervention; you can pursue debt consolidation on your own.
Potential Options for Debt Consolidation
At this point, it’s worth mentioning that debt consolidation comes in a wide range of forms. While they all revolve around the same end goal, each one is geared toward different needs and circumstances. This makes it a versatile debt relief solution.
Conventional Debt Consolidation Loans
Various banks, credit unions, and other lenders offer loans specifically for the purpose of debt consolidation. While getting the most beneficial interest rates typically requires a credit score in the high 600s or better, some financial institutions consider current accountholders strongly. At the same time, certain lenders handle the entire effort for you, automatically distributing the consolidation loan amongst your creditors. Fees do typically apply, though, so be sure to read the legally required fine print before signing on the dotted line.
Unsecured Personal Loans
Some lenders don’t offer debt consolidation loans per se, but they do provide personal loans to be used at your own discretion. Though they’ll most likely ask the purpose of the loan, admitting it’s for debt consolidation won’t disqualify you. As is the case with the more specific counterparts, decent credit scores are necessary to get lower interest rates on personal loans. Since they’re not technically consolidation loans, they don’t usually come with the option of automatic distribution. You’ll be responsible for using the loan to pay off chosen creditors, and if you run into problems along the way, help probably won’t be available.
Where qualification is concerned, credit scores aren’t quite as important with secured loans because they’re backed by collateral. Still, the better your score, the lower your interest rate will be. Keep in mind though that if you fall behind or default on a secured loan, you’ll lose whatever you offered as collateral. This could cost you a great deal more than you bargained for in the end.
Home Equity Loans
If you’re current on your mortgage payments and your home is worth more than the balance owed, you may be able to qualify for a loan based on positive equity. Since you’d be borrowing against the value of your home, a shaky credit score wouldn’t keep you from acquiring a home equity loan; however, it would affect the interest rate. This is a secured loan and your property acts as collateral, so defaulting would leave you without a home.
Home equity lines of credit offer borrowers another type of opportunity to take advantage of the positive value in their homes. Your lender would essentially extend a certain amount of available funds to be used how and when you see fit for a specified length of time. Once this period has passed, you’d be expected to begin paying off any amount you borrowed against your home’s equity. This could be considered the riskiest as well as the least effective option available. Not only is your home collateral, but interest rates change by the day based on just how much of the accessible funds you’ve used. While HELOCs aren’t generally recommended for debt consolidation, they could be effective if used in the right way. Although you can take out a home equity line of credit on your own, consulting with an unbiased professional beforehand is highly recommended.
Credit Card Balance Transfer
Balance transfers allow you to pay off certain debts by sliding them over to a single credit card. Cards with low or no interest and zero-dollar transfer rates are available, but they’re not exactly easy to come by. In order to qualify for them, you generally have to hold a near-perfect credit score. In addition, keep in mind that those low transfer fees and interest rates are introductory offers and typically only last for a few months. Some hold out for a year or two. However, if you can’t pay off the collective transferred balance within this grace period, you could end up paying outrageous interest rates and losing out over the long term.
Several different consolidation opportunities are available, so credit score isn’t a sole deciding factor here. That said; it does tend to make a considerable difference in the interest rates being presented to you. Exercise caution when deciding which solution to use in order to avoid problems down the road.
Using Debt Consolidation Laws to Maximize Your Benefits
As mentioned, debt consolidation entails combining multiple bills into one bill. One monthly payment is far simpler to keep track of than several are, so simplicity would be a significant benefit of this option. With knowledge of your rights on your side, other advantages also apply.
With the right debt consolidation loan, you could save a great deal of money on interest alone. You’d have more funds to invest in the future, your children’s educations, and other worthy pursuits. Lenders and debt management agencies are obligated to fill you in on monthly payment amounts, interest rates, terms, and additional fees to guarantee you’re aware of whether you’d actually be saving money with the option you’re considering.
Getting out of debt could also potentially take far less time than it would otherwise with debt consolidation because you should be paying less interest than the total of those original monthly payments. As they say, time is money. Be cautious if the term being offered seems impossibly short, though. If so, chances are strong that some of your debts didn’t make their way into the mix, or you’re being deceived in some other way.
Preserving Your Credit
If you’re struggling with high-interest credit cards and numerous other debts, you’ll likely fall behind, eventually. As a result, your credit score and future borrowing ability are bound to suffer. Debt consolidation can help circumvent this roadblock by providing greater manageability, as long as payments are reaching their intended recipients. In the event a debt management company is involved and pocketing a portion of your monthly deposits, your credit could suffer without you even knowing until it’s too late.
Plenty can also be said for the do-it-yourself options available with this solution. In most cases, you can seek out consolidation options on your own. Many of the other debt relief routes require professional or legal intervention. As fate would have it, this expert assistance often generates additional expenses. Unfortunately, a number of these extra outlays are the result of unscrupulous businesses looking to line their own pockets rather than help the consumer.
What Are the Downsides of Debt Consolidation?
Far too many people have rushed into debt consolidation without looking at the matter from a long-term perspective. This futile mistake leaves them paying more with debt consolidation than they ultimately would’ve if they’d just stuck with their original monthly obligations. If you don’t do the math and spend some time researching and investigating, this option could easily backfire.
Another drawback stems from newfound security. Reducing monthly payments frees up money in the budget, and this tends to encourage extra spending. Those who give in to temptation often find themselves even deeper in debt over time. It’s the same scenario as finding a half-price sale and then buying twice the merchandise.
Aside from those issues, a number of consumers hit a snag because of their current credit standings. Without the right credit score, you’re not likely to qualify for any of the truly effective debt consolidation options. Some exceptions to this rule do exist, though, so credit score isn’t always a hurdle. While lenders are expected to offer fair interest rates, fair is a highly subjective term. Ensuring you’re really getting a favorable interest rate requires doing your due diligence.
Is Debt Consolidation the Right Choice for Me?
Debt consolidation is a promising solution for many people, but it’s not the ideal choice for everyone. If you’re trapped under numerous debts with high interest rates, it could undoubtedly work out in your favor. Those who are paying unusually high additional charges, such as administration fees, might also benefit from rolling their balances over to a single, less greedy lender. In the event, you just can’t keep up with multiple monthly bills and this is causing you to fall behind, consolidation might not be a bad decision.
With this in mind, look at the types and amount of debt you have as well as your income. To succeed with debt consolidation, your monthly income needs to exceed your debt after utilities and other necessities have been factored into the equation. Those who’ve already fallen behind on their bills may be better served by another alternative. If you’re considering consolidation simply because having a little more spending money in your pocket each month sounds nice, you may be looking at the situation from the wrong perspective.
Additionally, take into account the types of debt you have, as not all are considered negative. Those potentially generating value over time or increasing your own worth aren’t frowned upon in the lending world. Mortgages and student loans are a couple of the outlays falling into the category of good debt, as long as they’re accompanied by fair interest rates, because they have a way of providing merit.
Dishonest credit counseling and debt management companies may try to convince you otherwise, but don’t be taken in by their false claims. If they state they can get rid of all your debt through consolidation, they’re probably exaggerating because secured debts aren’t included in this solution.
At the same time, completely eliminating all debt and letting your borrowing status grow stale isn’t necessarily a positive move. Doing so could actually decrease your creditworthiness down the road. Lenders generally want to see active but not excessive credit. Do you remember when you were just starting out and couldn’t get a loan because you had no credit at all? You don’t want to revert to that state because it’s often just as harmful as having bad credit.
In a Nutshell
Debt consolidation can help free you from unreasonable interest rates by rolling several monthly outlays into a single payment. Success does involve taking out a loan with more favorable terms than those already on the table, so not everyone is eligible for or suited to this option. Numerous alternatives are available if you don’t qualify for this particular solution, though.
Debt consolidation is largely a DIY venture. If you don’t feel comfortable going it alone, or you prefer to have a professional advocate on your side, help is certainly available. Should you choose to seek assistance from a third party, protect yourself by checking credentials beforehand.
Don’t commit to any debt consolidation loan without digging deeper. For the mathematically challenged among us, online calculators are readily available, and they can approach your debt from a wide range of perspectives. Find one or a combination of them that works best for you and use this tool to your utmost advantage. Aside from looking for lower interest rates, consider term length, underlying charges, and any other fine print possibly coming into play before signing on the dotted line.
Overall, debt consolidation can be an effective solution to mounting debt as long as you crunch the numbers, explore all your options, and follow through with your efforts once they’re underway. Understanding the laws regarding this debt relief option gives you a great deal of power in making the best choice based on your circumstances.