Debt consolidation describes many ways of taking several debts and packaging them into one debt with one interest charge and one monthly payment. One payment is easier to remember and budget for than several, but often it doesn't save consumers money, despite advertisements to the contrary. If a consumer decides he needs to consolidate debt, there are wiser ways and riskier ways to do so.
Debt Consolidation Companies
Debt consolidation companies promise to take an unwieldy stack of debt, reduce it to one payment that is lower than what you are currently paying and end harassing phone calls from creditors. What they don't advertise is that they charge a monthly fee of about 10 percent of the money they pay your creditors monthly. In addition, lower payment often comes with an interest rate of 21 or 22 percent, so you wind up paying more in the long run than if you had simply paid your bills. Sometimes much more.
Best Debt Consolidation Moves
There are ways to consolidate debt and save yourself money, but it takes more legwork. If you qualify for a personal installment loan, you can take out a loan from a bank or credit union, pay off other debts and have only the one loan. The interest rate is likely to be lower than the one on a credit card that's had a payment skipped. Credit agencies look more kindly on installment loans than a raft of credit card balances.
Risking Home or Car
If your credit is in rough shape, you may be tempted to go for a loan that's easier because you can secure it with your house or your car. If you have equity in your car, you may be able to refinance your car loan and get cash back to pay other loans. You may be able to get a home equity line of credit, which is borrowing what you already paid on your mortgage and paying it back. You can borrow again from a line of credit, or you could get a second mortgage. All these consolidation moves, however, could make you lose your home or car.
Playing the Credit Card Shell Game
Some people transfer balances from a higher rate card to a low or no interest rate card with the idea that they will pay off the card while escaping the interest and get debt free that way. The trouble is that most people with this strategy have already discovered they are not particularly self disciplined when it comes to credit. Statistically, most wind up racking up a balance on both cards. If you do protect yourself against the inherent danger by canceling cards, make sure it says canceled at the card holder's request. Either way, canceling cards can look bad on credit reports, too.
Consumer Credit Counseling
One smart approach to debt consolidation is to talk to a consumer credit counselor recommended by the Association for Independent Consumer Credit Counseling Agencies or the National Foundation for Credit Counseling (see Resources). These counselors offer free advice on paying off debts. They might help a consumer set up a self-managed plan for taking care of debt for no cost. They will, if requested, consolidate unsecured debt and negotiate lower fees and interest rates with creditors. The advice is free; managing the debt usually costs around 8 percent or $35, whichever is less. They won't tack on an exorbitant interest rate.
Doing the Math
The first step in figuring out the wisdom of debt consolidation might be figuring out what you will likely pay in fees and interest on each debt, adding up the cost and seeing what you can expect to pay out-of-pocket. This will help you determine which debt management approach would work best for you.
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