Debt Consolidation - What does it really mean
to you?
Debt
consolidation is one of those financial terms that's
thrown around a lot these days and it tends to get lumped in
with things like debt settlement, debt management, and even
bankruptcy. Although all of these things relate to the issue of
debt, debt consolidation is not very similar to other forms of
debt relief. For some people, it can be better.
Unlike bankruptcy, you do not need a court order to go into
debt consolidation. Unlike debt management, you do not need a
counselor or agent to act on your behalf. And unlike most plans
of debt relief, debt consolidation done correctly will not hurt
your credit score or your financial reputation.
Of course, debt consolidation is not for
everyone. Financial woes have a way of being unique, and every
single person or family facing mounting debts has a lot of
special factors that come into play. Financial programs to help
cope with debt are definitely not one-size-fits- all. Besides
that, not everyone (even those who want and need it) can
qualify for debt consolidation.
Quite simply, debt consolidation is a way of rolling many debts
together, taking out another loan to pay them off, and then
managing the consolidated debt. In other words, you take out a
big loan, use it to pay off all of your credit cards and other
debts, and then pay off the big loan. This sounds
counter-intuitive. A person drowning in debt probably hates the
thought of another debt! And how can adding one more colossal
debt to the mixture help you?
The answer is not that you are simply getting another loan,
it's really a way of re-organizing or re-structuring your
debts. For example, let's say you have seven credit cards.
You're maxed out on three and you owe differing amounts on the
other four. Altogether, you owe $82,000 on credit cards. Add to
that $22,000 in car notes and perhaps $4,000 on a revolving
plan to buy furniture and your total debt is $104,000. That may
sound high to some people, but it is really not all that
unusual!
Now look at the interest rates on those loans. This can take
some detective work, but that information should be available
on your monthly statements. If it is not or you can't find it
(or figure out what they're talking about), call the toll-free
customer service number most such companies have and discuss
the loan with them. You want to know the interest rate, which
is the percentage of the total loan the company charges you for
the privilege of borrowing its money.
You will probably discover that interest rates are all over the
map. Department store credit cards are traditionally pretty
high (22% is not unheard of). Other credit cards span a pretty
broad range (16% to 20% is fairly normal). An in-store loan for
furniture is likely high (22% is typical) but the car note
might be half that (10% to 12%...again, these vary widely).
If you have debt, you are paying not just the actual amount you
borrowed, you're also paying interest. Interest is the dirty
little secret of debt because it keeps accruing, day after day
after day. The longer you take to pay your loan, the more
interest you'll pay. In fact, if you take long enough to pay
off a high-interest loan, you can wind up paying more in
interest than the loan itself!!
Think of sales tax. Here in Texas, where I live, we pay 8.25%.
That seems high to me, and most of my fellow Texans will agree.
But most interest rates on credit cards is double that-over
16%. Imagine paying double sales tax! That's how interest can
really add up.
Coming back to our example, you owe $104,000 at a variety of
interest rates. What if you could get a loan for $104,000 at,
say, 12%. Would that make sense? You now swap out your many
smaller loans for one giant loan at a much lower interest
rate.
But let's look at the car note. If you're paying 12% or less
interest on that, it would not make sense to pay it off and
then take out a new loan at the same or higher interest!
Can you actually find lower interest rates? A lot depends on
how low you need to go, how good your credit is, and many other
factors. A big plus in debt consolidation is home ownership. If
you own your own home, you may be able to get a home equity
loan or refinance the mortgage in such a way that you can
extract money from your home to pay off your debts. A mortgage
company, banker, or debt consolidation professional can help
you figure out if that works.
If you do not own your own home, do not give up. Debt
consolidation may still be possible using a line of
credit (a type of unsecured loan obtained through a bank,
credit union, or financial institution) . You may also be able
to borrow money using something else of value (a 401(k)
account, stock account, property) as collateral. Any time you
have collateral, it's easier to get a loan and you'll likely
have more clout in getting lower interest rates. That is
because collateral means lower risk to the lender. If you put
up your retirement account as collateral for a loan, the lender
has the right to take funds from your retirement account to pay
off the loan.
It is tough to make broad statements about debt consolidation,
but you are a pretty good candidate if you have an
uncomfortable amount of debt and at least two of these things
is true about you: (a) you own your own home, even if it's
mortgaged, (b) you have a lot of debt at interest rates around
20% or higher, (c) you have good credit.
There are some definite advantages to debt consolidation.
First, because you pay off your debts, it does not hurt your
credit score and may even help it. Second, it is an ethical
solution that allows you to pay your debts (one of the dirty
little secrets of bankruptcy is that many people who file for
this sort of protection end up feeling ashamed). Third, it is
smart money management.
However, before embarking on a
debt consolidation loan, you need to get the facts.
There are lots of online and offline places to seek information
and there are also companies and counselors who can advise you.
One often overlooked source of information is your own hometown
bank. Bankers know a great deal about borrowing money and can
probably give you free advice if you call and make an
appointment. (It's more likely you'll get high-quality face
time with a professional at a bank if you're a customer, but I
have heard of people getting great free financial advice from
banks they did not even bank at!)
Keep your eyes open if you consolidate debt. Debt consolidation
does not make debt disappear: you still have to pay it off. It
also does not really help you change your financial ways;
you'll have to take steps yourself to keep from digging
yourself into debt again. But for the right people,
debt consolidation can be a great way to
manage overwhelming debt sensibly.
About the Author:
Mandy Karlik is a freelance writer. To read more of what she
has to say about the basics of debt consolidation, click
through to http://www.debt-
consolidation- diva.com .
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