Debt Consolidation

Household debt levels surpassed household income by more than eight percent, reaching 108.4 percent in 2005, according to a May 2006 study by the Center for American Progress.  Consumer debt is now at a record $2.17 trillion reports the Federal Reserve Board, and consumers cashed out $431 billion in home equity last year.  Consumer credit card debt has almost tripled over the last two decades, from $238 billion in 1989 to $800 billion in 2005, according to an analysis of Federal Reserve Board data by Demos, a national research and consumer advocacy group.  The average American family now owes more than $9,000 in credit debt, according to the Consumer Credit Counseling Service of Greater Dallas.

Americans have several choices for dealing with their non-mortgage debt problem: pay the minimums (which will extend repayments over years and cost thousands of additional dollars in interest); consolidate through other debt instruments (e.g., other credit cards, personal loans, home equity, refinance); or file for bankruptcy (even though the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 was to stem the amount of filings, over 2 million individuals filed for bankruptcy protection in 2006).  Statistics have shown that most U.S. consumers took their equity from their homes to pay principal and interest on non-mortgage debt (source: The Northern Trust company). 

DEBT CONSOLIDATION

To get your finances in order, you may need to consolidate your debt.  Many consumers use home equity loans, mortgage refinancing, and personal installment loans to consolidate their debt (credit cards, personal loans, and automobile loans) into one loan.  The advantage is that you have one monthly payment (which is usually lower) and the finance charges are fixed (with the exception of home equity lines of credit) and will not adjust (unlike revolving finance charges normally associated with credit cards).  In addition, the interest rate will most likely be substantially lower than your credit card interest rates.

Home Debt Consolidation

If you're paying high interest rates on credit card balances, a competitively priced debt consolidation loan could save you a significant amount of money over time.  Mortgage refinances, home equity loans, and home equity lines of credit typically have lower interest rates than unsecured loans and credit cards, meaning you can save on interest payments and potentially free up some of your cash to pay down more of the principal balance.  In addition, with home equity products, you can potentially deduct 100% of the interest, unlike non-equity products like credit cards, personal loans, or auto loans. (Consult a tax advisor for more information.)

Home Refinance

Homeowners can consolidate their short-term debts (including auto and/or personal loans) when they refinance their mortgage.  Given the lower mortgage interest rates, homeowners can lower their monthly payments by hundreds of dollars.  Consolidating all of the loans may not change your current mortgage payment, but will take care of short-term debts by spreading the payment over a longer period of time and also provide tax benefits. 

Home Equity Loans

Established homeowners have an additional source of funds available to them.  A home equity loan, or second mortgage, allows the consumer to borrow against the equity in his or her property.  Equity is the difference between what is owed on a house and its current market value.  A home equity loan may be used for almost anything including home improvements, college tuition or bill consolidation.  The loan can either be a simple installment loan or revolving loan.  A revolving loan gives the borrower a line of credit to be accessed with checks, allowing it to be used again as needed.  Funds can be used in varying amounts at any time and, as payments are made, the credit line is restored.

Based on your personal financial situation, you may be able to borrow up to 100% of your available home equity.  Payments are usually made over a longer term than with other types of consumer loans.  Interest rates may be lower than with most personal loans because the lender assumes little risk.  In addition, the interest may be tax-deductible (consult your tax advisor).  Home equity loans can be obtained from a variety of sources such as commercial banks, finance companies, credit unions, and savings and loans. 

Auto Loans

Just like refinancing your home mortgage loan, you can refinance your auto/vehicle loan.  Auto refinancing is best applied if your credit has become substantially better and you have more than half of the payments still due.  Most banks do not charge any fees for refinancing a loan (and you can even refinance with the existing lender).

Personal Loans

The uses for this type of loan vary.  Payments are made in weekly or monthly installments, and the loan is generally repaid within 12 to 36 months or longer.  A lender may or may not require collateral, depending on the borrower's financial situation and intended use of the loan.  Finance charges and the amount and term of the loan vary depending on the lender.

Credit Cards Balance Transfers

A marketing practice currently in use in the industry is the offer of low-interest rates for balance transfers.  Credit card companies offer a promotional interest rate (usually 1.9% - 7.9%) to transfer balances from a competitor’s credit card.  The promotional offer normally lasts about four to nine months; thereafter, the unpaid balance will be subject to the card’s stated interest rate (either fixed or variable, but usually 10% higher).

It’s important to understand the relationship of finance charges to new purchases while you have a promotional balance.  Most promotional rate solicitations will include a statement that reads: “We may allocate your monthly payments to your promotional APR balance(s) before your non-promotional APR balance(s).”  This means that any monthly payment you make that is not the full amount will be first applied to the promotional rate balance amount before being applied to any new purchases.  

Credit Counseling

If you’re not disciplined enough to create a workable budget and stick to it, can’t work out a repayment plan with your creditors, or can’t keep track of mounting bills, consider contacting a credit counseling organization.  Many credit counseling organizations are nonprofit and work with you to solve your financial problems.  But be aware that just because an organization says it’s “nonprofit,” there’s no guarantee that its services are free, affordable, or even legitimate.  In fact, some credit counseling organizations charge high fees, which may be hidden, or pressure consumers to make large “voluntary” contributions that can cause more debt.

Most credit counselors offer services through local offices, the Internet, or over the telephone.  If possible, find an organization that offers in-person counseling.  Many universities, military bases, credit unions, housing authorities, and branches of the U.S. Cooperative Extension Service operate nonprofit credit counseling programs.  Your financial institution, local consumer protection agency, and friends and family also may be good sources of information and referrals.

Reputable credit counseling organizations can advise you on managing your money and debts, help you develop a budget, and offer free educational materials and workshops.  Their counselors are certified and trained in the areas of consumer credit, money and debt management, and budgeting.  Counselors discuss your entire financial situation with you, and help you develop a personalized plan to solve your money problems. An initial counseling session typically lasts an hour, with an offer of follow-up sessions.

Caution!

The main problem with consolidating debt into one loan is that many people will go out and incur more debt, especially on credit cards.  This defeats the purpose of getting a handle on credit with one loan.  You need a clear understanding of the implications of consolidating debt, especially when using a home as collateral.

It’s important to keep in mind that a debt consolidation loan simply transfers the old debt to a new lender, so you will still have debt.  The key to success is discipline.  If you’re consolidating credit card bills, don’t start using the card again, even if you’ve cleared your balances.  You could be tempted to overspend, and this would defeat the whole purpose of consolidating.

A Final Comment

Contact your creditors immediately if you’re having trouble making ends meet.  Tell them why it’s difficult for you, and try to work out a modified payment plan that reduces your payments to a more manageable level.  Don’t wait until your accounts have been turned over to a debt collector.  At that point, your creditors have given up on you.

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