Introduction
Every year, thousands of people find themselves overwhelmed by credit woes. Often a person will have accumulated so much debt on their credit card (or cards) that it has become too much of a challenge to pay more than the monthly minimum. For some people, the only viable option is using a debt consolidation company to help resolve their debts. Debt consolidation is a good way to keep yourself out of bankruptcy and to get back on the road to financial stability.
The Process
On the surface, a debt consolidation company works in a very simple way--it takes your debt and consolidates it under one bill, which is paid to the company. The consolidators then pay all your debtors. Of course, this is an over-simplification. Dig a little deeper, and the process is much more beautifully orchestrated. They will negotiate lower interest rates with your debtors, work to change your due dates, and sometimes get the creditors to waive extra fees and charges that are making it that much more difficult to pay them. It will pay each company separately, and allocate a higher portion of the total amount to the creditors with the highest interest rate (or the highest balance, which is sometimes the same creditor). Once that card is paid off, the money they were paying then gets split among the other debts, and it keeps snowballing until all the bills are paid.
Tom, a Good Example
Let's say Tom owes $15,000 in credit card debt to three different companies, one card at 15 percent interest ($200 per month minimum), one at 22 percent ($250 per month minimum), and one at 16 percent ($200 per month minimum). Making just his minimum payments of $650 combined, Tom will eventually pay off his debt over then next 20 to 30 years. That is only if he doesn't ever use his credit cards again. Tom hires Company Z for debt consolidation to help him pay off these bills faster.
Company Z will then compile a list of all his creditors (a short list in this case), and negotiate a lower interest rate on each one. In this example, Company Z was able to lower each of his interest rates to 7 percent. They can do this because they will assure the credit card companies that the payment will be on time. Company Z has now lowered Tom's monthly payments to somewhere in the neighborhood of $300. With this lower monthly payment, Tom can more easily afford the debt, and no longer has to remember to write three separate checks per month. Because of the lower interest rates, he will now have all three balances paid off in less than 6 years.
What Will It Cost Tom?
Debt consolidators don't perform this service for free, even if they are one of the few nonprofit consolidators. There is often a one-time fee (anywhere from $50 or up) or a monthly fee (usually based on a percentage of the bill), but with the savings Tom gets from lower interest rates, he can afford that little bit extra. Other than the financial cost to Tom, he can expect to see two other side effects: a lower credit score (for a while) and he can't apply for any new credit. Joining a debt consolidation program will show up on your credit report and remain there for at least 7 years. it doesn't look good to a bank that wants to give you a home loan. It does, however, look better than bankruptcy. Because of the nature of credit card debt and how difficult it is to pay it off, most debt consolidators will not allow you to open any new lines of credit without specifically receiving their permission. Think of this as "financial babysitting." Tom will now have to live a cash-based lifestyle until his debts are paid off. Simply put, this means that if Tom wants something, he has to have the money for it first: good advice for anybody.
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