When people realize that they are in over their head when it comes to their debts, many turn to debt counseling for help and advice. In many cases, this is a good move that can save consumers from having to turn to turn to bankruptcy or other drastic measures.
While often a wise move, there are some things that you should know about debt counseling. The first important fact is that not all debt counseling services are the same.
Some are truly there to help consumers that are in trouble. They will work with you and will charge, at most, a very modest monthly fee (some will charge nothing). While debt counseling does affect your credit score, a reputable debt counseling service will not do as much damage as one that is simply out to make money. Below is a description of how each would operate.
Reputable Debt Counselor
This type of debt counselor would sit down with you and have you list all of your monthly expenses along with your income. They would then contact each of your creditors and negotiate payment arrangements. This may include a reduction in the total amount due, stopping or reducing the interest rate and lowering your minimum monthly payment.
Next, they would instruct you how much you would need to pay the agency each month and then the debt counseling agency would pay each of your creditors each month, starting from the month after you join the program.
The "Other" Kind of Debt Counselor
The unsavory debt counselors often handle things a bit differently. The first part of the process is the same, but after you provide the list of creditors and start sending your monthly payments to the agency, the similarities stop.
Instead of sending a payment each month to your creditors, the agency instead holds onto to all of the money that you send until each creditor charges off your account. At that time, the agency negotiates a settlement amount and pays off the account.
Keep in mind that you will still be sending payments equal to the entire amount that you owed during your initial consultation. So what happens to all the extra money? It is pure profit for the debt counseling agency.
Because each of your debts is being charged off, using this type of debt counseling agency is far more harmful to your credit than using the services of a reputable agency.
As mentioned earlier, using a debt counselor will have an impact on your credit score. For that reason, you should weigh all of your options before deciding to you use one. If you simply cannot make at least your minimum payments, you could try to work directly with your creditors.
Some will be willing to temporarily lower your interest rate or minimum payment to help you get through a tough time. Be sure to ask if they will report such activity to the credit bureaus. Some will and others will not.
If there is no way that you can make it work and you have tried dealing with your creditors directly, then using a debt counselor is a sensible next step. Just be sure to choose one that is not going to do more harm than good.
Ask exactly how they handle the payments to your creditors. Be sure that they do not wait for the debts to be charged off before negotiating a settlement amount. You should get all of the details in writing so that there will be no confusion. Also, it wouldn’t hurt to call your creditors just to be sure that they are, in fact, receiving the payments.
Some mistakenly think that a debt counselor is going to help make your debt go away. While the goal of a good debt counseling agency will be to assist you reach your goal of becoming debt free, you will still need to pay the debt.
What a debt counselor will do is help you get a lower interest rate and ease the process of making the payments by having you write one check to them each month.
More importantly, they will help you learn to budget and to better manage your money so that you do not end up in the same situation in the future.
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Debt consolidation or a consolidation loan is a process consumers can use to combine their loans and liabilities into one loan. This means that instead of paying several separate bills each month, you get a loan with a bank, credit union or other financial institution to get a payment that is smaller than the total of the prior payments.
This payment is smaller because the debt can be paid over a longer period of time, and/or the interest is lower. Another advantage is to get a fixed rate loan if some of your debts have fluctuating rates.
How do I start?
Make a list of what debts you have. Include the balance owed, the monthly payment and the interest you are paying on each account and how many payments are left for each bill. This way you will know where to start. You’ll have an idea of how much money you need and at what rate it needs to be to save you money.
Depending on how much money you need, you will be able to decide if the loan can be an unsecured loan – usually limited to $5000, or if you need above this number you will probably need a secured loan. A secured loan might include tying the loan to refinancing your house or taking a second mortgage.
Securing the loan with some collateral should allow you to get a lower interest rate than you would get with an unsecured or personal loan. You get a lower rate because the lender can take the asset from you and sell it to get their money back if you don’t default on the loan.
Now that you know what you need, pull your credit report and make sure the things that are on it are correct and that everything is yours. Then go to one of the debt consolidation sites and see what types of loans and interest rates are possible. Talk to your bank and compare what their options are.
Is consolidating my debts a good idea?
Every person’s situation is different. Go back to your list. Look at how long you have left for these loans and what the interest rate is. Loan consolidation can be very advantageous if you have several small loans with higher interest rates. For instance the balance on your credit cards runs to several thousand dollars and the interest is in double digits.
If you roll it into a home mortgage, you might be able to cut the interest rates in half. The downside is you pay that interest on the balance for fifteen or more years, depending on the term of the mortgage. There are websites out there that have calculators for figuring out the cost of debt if you owe X with Y% interest and have Z years left to pay. Figure this out for each of your debts and total that number.
Then take the new amount you need to borrow to cover all these loans, what you think your interest rate might be, and the term. If you are including this as a refinanced mortgage, the term would be the length of your mortgage. What is the total?
One of the great calculators out there is the one on www.moneycentral.msn.com. The ‘consolidate your debt time frame calculator’ can help you play with the options and make an educated decision.
What is the biggest danger for Debt Consolidation?
Getting the debt consolidation loan and using it on something other than paying off the debts you got the loan for. It is important that if you get a loan to pay off smaller loans that you actually take the money and pay off all those loans. You might be tempted to keep some of it and use it for something else. If you spend the money somewhere else, you’ll end up with the old loan payment, and a new one.
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In financial circles, the definition of debt consolidation or a consolidation loan looks like this: it’s a "strategy used by a consumer to manage their debt," or it’s a “process of combining several loans or liabilities into one loan.”
Note the words strategy and process. Strategy implies that you know what you’re trying to accomplish and are taking proactive measures to reach certain goals. Process on the other hand leaves you feeling as if you are being pushed and pulled along some giant stairwell that takes you where you really don’t want to go.
No matter what definition you use, debt consolidation means that instead of paying off several separate bills each month, you plan to consolidate your loans with a bank, credit union, or other financial institution. The reason for doing this is to get one payment that is smaller than the combined total of all the other payments.
The smaller payment occurs because the debt has a longer time to be paid, or possibly provides you with a better interest rate. You might want to consolidate your debt to secure a fixed interest rate if one or more of your smaller loans have fluctuating rates.
The first step in consolidating your debts is to know what you have. Make a list of each loan and include the overall balance, the monthly payment and the interest for the current loan. This allows you to know what your situation is now, before you make a decision on a new loan.
The new loan might be an unsecured loan, or you may be refinancing cars or other secured items and adding an amount that will allow you to pay off a few smaller loans. Unsecured loans are sometimes called signature loans, or personal loans.
Securing the loan means tying it to an asset. Debt Consolidation can be done as part of a first or second mortgage. This allows you to roll short-term debt into a home mortgage loan, either when you buy the house or later as part of a refinance package or second mortgage.
For a mortgage, the asset is your house. But again, the asset could be a car, or boat, or even savings CDs that you have at the bank giving you the loan. Another word for asset is collateral and securing a loan with this collateral is sometimes called ‘collateralization’ of the loan.
Usually securing the loan with an asset or some collateral allows you to get a lower interest rate than you would get with an unsecured loan. This is because if you fail to make your payments, the lender – either a bank or other financial institution – can take the asset from you and sell it to get their money back. Since the lender has a reduced risk of losing their money, you get a lower interest rate for your loan.
Loan consolidation can be very advantageous if you have several small loans with higher interest rates. For instance the balance on your credit cards runs to several thousand dollars and the interest is in double digits. If you roll it into a home mortgage, you might be able to cut the interest rates in half. The downside is you pay that interest on the balance for fifteen or more years, depending on the term of the mortgage.
Debt Consolidation sometimes occurs when people or businesses have credit problems. It is important that if you get a loan to pay off smaller loans that you actually take the money and pay off those loans. Many people get into trouble when they decide to do a consolidation loan and then spend the money somewhere else. This leaves them with all the old loans, and a new payment.
Referencing the definitions at the beginning of the article, debt consolidation can be a strategy, or a process. Do your research and ask questions. Read all the information on the company and consolidation loan you’re considering, and make an informed decision, then you can be proactive and strategize your next move. Or you can scramble, let the ‘process’ drive your moves and go with the first thing that comes along.
Which definition do you want your debt consolidation to be? Is this going to be a strategy or a process?
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