Recent statistics on household debt in America show a troubling trend. Not since the beginning of the Great Recession has household debt reached such lofty highs, and debt accumulation among Americans shows no signs of slowing down. According to a recent report by the New York Federal Reserve, household debt at the end of the first quarter 2017 was a staggering $12.73 trillion. That’s an increase of over $50 billion just from the end of 2016.
The amount of household debt Americans added in 2016 was the largest increase in the last 10 years. This is because banks and other lenders are finally beginning to relax the strict lending practices implemented after the financial meltdown in 2008. In addition, many Americans whose credit rating took a big hit have sufficiently healed their credit enough for banks and other lending institutions to see them as creditworthy.
Now that the economy is starting to recover, consumers are optimistic about the future and are willing and able to spend money on things such as cars, household goods, and even second homes. Still, the cost of living is outpacing income growth, as it has been for nearly a decade. This makes it difficult for consumers to make ends meet, which pushes them into debt purely by necessity.
Still another indication of consumer optimism and the easing of lending practices is the rapid rise in mortgage originations. In 2016, Americans initiated the highest number of mortgages since the Great Recession. However, while mortgages represent the largest subsection of household debt, Americans are still carrying a heavy load of other debt, such as auto loans, student loans, and credit card debt.
Why Are Americans Carrying So Much Debt?
Many Americans have accumulated high levels of debt simply because they do not have enough income to meet the everyday cost of living. In addition, most Americans have little to no savings to guard against financial emergencies. This leaves them vulnerable and likely to use credit to pay for unexpected expenses. For many Americans, living paycheck to paycheck is a way of life.
Additionally, most Americans have little to no skill in managing money and other financial affairs. Because of this, most families do not have a defined budget and consistently spend more money than they make. When this happens month after month, credit card debt rises accordingly. Within a short period, they have accumulated a substantial amount of debt. At some point, they will reach a critical stage where they have run out of credit. If they wait too long to address the problem, options become extremely limited.
Those that recognize the situation they are in can take steps to stop the accumulation of debt and get on the road to better financial health. There is really only one way out of debt: stop the bleeding of overspending every month and create an avenue to pay off accumulated debt. Cutting expenses, increasing income (if possible), and creating a payoff plan are essential to getting control of your debt.
A popular payoff plan to consider is consolidating your debt through a debt consolidation loan. These loans have both advantages and disadvantages that consumers should be aware of before signing on the dotted line.
Pros and Cons of Debt Consolidation Loans
Consumers look to debt consolidation loans to address their debt problem for a number of reasons. The simplicity of making one payment to one creditor each month can ease the chaos around suffocating debt and help consumers feel more in control of their finances. If they are chronically behind in paying their bills, a debt consolidation loan gives them a fresh slate and a chance to repair their credit score. Often, a lower interest rate and better terms mean that the one payment you make on the debt consolidation loan will be lower than the sum of all your previous payments combined. All these factors make a debt consolidation loan an attractive option for many consumers.
While debt consolidation can be an intriguing option for many consumers, there are some downsides that every consumer should be aware when considering a debt consolidation loan. First, and most importantly, consumers need to be honest about how they got into debt in the first place. If it is a matter of your income not being sufficient to cover your basic living expenses, address this shortfall immediately. You may need to cut expenses, add income, or do both.
Debt consolidation loans can certainly help decrease the amount of money you are paying out each month, but if you are not watching your money, the surplus can easily disappear just in everyday spending. It’s possible that you could soon realize you are relying on credit cards again.
Making important lifestyle changes and learning how to budget your money are important steps to take if you are serious about lowering your debt. If you are still chronically overspending, it is likely that not much will change, even if you are successful in consolidating your debt. Chances are strong that you will get yourself into more trouble with debt by adding new debt on top of your old debt.
If you have made a commitment to changing your spending habits, and you feel that debt consolidation is the smart move for you, there are several loan options available. Be sure to shop around to get the best interest rate and terms.
The Different Types of Debt Consolidation Loans
Consumers have several options to consider when choosing the best way to pay off their debt. If a debt consolidation loan is the choice, consumers should be familiar with the different types before making a decision. Some debt consolidation loans are secured loans, meaning the bank has required some type of property as collateral against the loan.
Generally, secured loans have the backing of real estate; in most cases, this is a home. Other types of debt consolidation loans are unsecured, meaning there is no collateral placed as a guarantee against the loan. With unsecured loans, the only thing the consumer has at risk is his or her credit score. Consumers should take the time to educate themselves on the differences and implications of secured and unsecured loans before choosing the right way to go based on individual circumstances.
Refinance of Your Current Mortgage
A popular option for many consumers is to refinance their current mortgage into a larger loan and take the excess cash out to pay off their credit cards and other debt. Proceeds from refinance cash out loans are usable for anything, so it’s a popular option for many looking to consolidate their debt. If mortgage market conditions are good, you may be able to obtain a lower interest rate, which will help you create more monthly cash flow. These advantages are very attractive, but consumers need to consider a few important matters before making the choice to roll all of their debt into their home mortgage.
First, your loan will require closing costs by the bank; you will have to pay these out of pocket upfront or add them to the balance of your loan. These closing costs could equal several thousand dollars and, added to the excess cash you need, this could mean adding a substantial amount to your home mortgage.
Additionally, it is important to remember that you will pay interest on these closing costs and the extra cash you take out for the life of the loan, usually 30 years. This could add up to a substantial amount of money.
Lastly, it is important to remember that when you roll your debt into your mortgage, you have now moved your credit card debt from an unsecured position to a position secured by your home. If you are ever in a position where you can no longer afford the larger mortgage, your home could be in jeopardy of foreclosure.
It’s also important to remember that you should have made all the important lifestyle changes necessary to assure you will not run up your credit card debt again. If you don’t make this important change, you could end up in a more difficult situation than when you started.
Home Equity Line of Credit (HELOC)
A home equity line of credit is a mortgage loan that allows the consumer to tap into the equity in his or her home. Generally, the bank will approve a line of credit up to a certain amount, and the homeowner can borrow money when needed. Then, the borrower can pay it back in any amount as long as he or she pays the interest accrued every month. Many consumers owe far less on their first mortgage than what their home is worth. If they bought their home during the depressed housing market of the last several years or they have owned their home for a long time, their home could have experienced quite a bit of appreciation.
The proceeds from a HELOC are usable for whatever the homeowner wants or needs, so paying off credit card debt is perfectly acceptable. However, many of the same considerations of a refinance with cash out loan apply. Remember that rolling your debt into your home mortgage can put your most valuable asset at risk. It also takes your debt from an unsecured position to one secured by your home, a potentially risky proposition. Moreover, you could be paying off that debt for a long period, meaning you could end up paying a lot more interest than if you just paid off your cards on your own.
Lastly, you will need to be very diligent in your efforts to control your budget and not run up your credit card debt again. If you aren’t, you could end up with a second mortgage on your home and an entirely new credit card debt problem.
Consumers who have good credit standing and are not behind on any of their credit card payments could obtain a personal loan from their bank or another lending institution. For those who do not have a large amount of credit card debt, this could be a good option. Generally, banks will have a limit on the amount of money they are willing to lend on a personal loan.
Personal loans allow consumers to borrow money on a signature, meaning there is no collateral, such a home, backing the loan. The purpose of loans like these is primarily to streamline monthly bill paying and help consumers pay off their debt quickly. Generally, this means they will have a much shorter loan term than with mortgage loans. The downside of these types of loans is that payments are not likely to be much lower than the amount you are already paying on your credit cards. However, you will pay much less interest on a short-term loan than you will on a long-term loan such as a mortgage.
Often, consumers don’t address their debt problem until the situation becomes difficult to resolve. If they wait too long, they may fall behind on their payments, hindering their ability to obtain a debt consolidation loan. Either credit has suffered damage to the degree that creditors are not willing to extend more credit, or the consumer does not have an asset to borrow against.
Before considering bankruptcy, consumers should consider working with a debt relief company. National Debt Relief helps clients struggling with credit card debt resolve their debt with credit card companies. Sometimes, this is a consumer’s only way out of overwhelming debt. The debt relief process takes time, and there may be some damage to your credit, but the damage will not be as severe as that caused by a bankruptcy.
With the many options available to consumers, there is no reason to wait until the situation is in a critical state. If you are drowning in credit card debt, it’s important that you don’t wait until you are facing bankruptcy. Start looking at your debt resolution options today!