Have you heard the story of the Greek king Sisyphus who was doomed to push a boulder up a hill every day only to see it roll back down so that he would have to start again the following day? If so, you may feel the same way about your debt – that there’s just no end in sight and you will never get it completely paid off. You have probably also heard about debt consolidation as a way to get your debts under control. While this is certainly a good alternative, it’s important you understand these six myths.
- There are companies with lower interest rates than others
- Credit counseling can get your monthly payments cut in half
- You can’t get out of debt without a formal program
- Some credit counseling agencies can negotiate lower DMP payments than others
- You will always save money through debt consolidation
- Bankruptcy is not a big deal
1. There are companies have lower interest rates than others
One way to consolidate debts is to get a loan and pay them off. You may have seen teaser ads for home equity loans with very low interest rates and feel this might be a good option. But the fact is you would need be on the A credit list to qualify for one of those very low rates. If you’re not on that A list, expect to pay the prime interest rate plus 4% or 5%, as well as a point or two in fees.
2. Credit counseling can get your monthly payments cut in half
What a good credit counselor can do is work with your creditors to get your interest rates reduced and any late payment penalty fees waived. This can mean a lower monthly payment than the sum of the monthly payments you’ve been making, but it won’t cut your payment by 50%. If a credit counselor tells you that he or she can get your payments cut in half, this is just a numbers fudging deal. As an example of this, if you missed two $200 payments on a $10,000 balance, your third month’s bill will be the $600 that you owe. If your counselor re-ages that bill and knocks your payment back to $200, the missing money will just be tacked back onto your total owed.
3. You can’t get out of debt without a formal program
The real truth here is that you can basically create your own debt management program. Almost all creditors, including the credit card companies, have special reduced-interest programs if you just contact them. Of course, you’ll have to make all those phone calls yourself and will need to know what to say. You will also have to be very persistent because you probably won’t get through to the company’s hardship program department on the first or even second call. And when you do get through you need to be polite, take full responsibility for your problems and be ready to request something specific such as a reduction in your interest rate.
4. Some credit counseling agencies can negotiate lower DMP payments than others
When you go to a consumer credit counseling agency, your counselor will help you create a DMP or debt management plan. He or she will contact your lenders and present your DMP for their approval. If all of them accept your plan, you will no longer be required to pay them. Instead, you will pay the credit-counseling agency each month and it will distribute the money to your creditors. However, it’s a myth that some credit counseling agencies can get you a lower DMP payment than others. The truth is that most lenders automatically move 95% of those individuals who are enrolled in a DMP into their own existing programs. This means that regardless of which credit counseling agency or company you choose, the odds are that you will get approximately the same program.
5. You will always save money with debt consolidation
If you choose to get a debt consolidation loan and you’re told this will save you money, get out your calculator and do the numbers. As an example of this, let’s assume that the lender tells you that he can get you financing with no out-of-pocket costs. In this case, make sure it’s not just rolling its fees into your loan where you would then have to pay interest on them. What you need to do is compare the total of your existing monthly payments to what your payments would be for that same amount of debt under your debt consolidation loan, including fees and any voluntary contributions. If you find that you’re not saving at least 5% to 10%, then a debt consolidation loan wouldn’t be a good choice.
It would also be a bad choice – according to this video with Suze Orman – to use a HELOC or home equity line of credit to pay off credit card debt.
Many young people are led to believe that a better answer than trying to pay off, say $7000 in debt is to declare bankruptcy. This can be very appealing because it’s possible to get an attorney to do a bankruptcy for as little as $500 – to discharge $7000 in debt. While this might sound very attractive, the damage that will be done to your credit will still be there long after you could have paid off that $7000 normally. The fact is, bankruptcy is a very severe solution and should be used only in circumstances such as cumulative debt of $50,000 on a $20,000 annual salary. The truth is that a bankruptcy will stay on your credit report for nearly 10 years. Plus, prospective employers look at credit reports and might refuse to hire you based on what they find in yours.