Stay Away From Debt Consolidation

Debt Consolidation Companies and Debt Consolidation Loans are
risky and not normally smart solutions to your financial woes.

Questions and answers about debt consolidation:
 

1.   Exactly what is debt consolidation?

Simply stated, debt consolidation is taking two or more monthly debt payments (usually several payments) and converting them into one monthly payment of a lesser amount. The devices used in a debt consolidation program that make it possible to reduce the amount you pay are: longer payment terms and lower interest rates. There are two distinct types of Debt Consolidation Programs: (1) Refinancing several smaller loans into one larger loan and (2) using an intermediary – usually referred to as a Debt Consolidator to make your monthly payments.
 

2.   Why is debt consolidation popular with consumers?

Many people buried in credit card debt with monthly cash requirements beyond their ability to pay use it because it takes care of their immediate needs which are: (1) to reduce the amount they have to pay out monthly and (2) to take the pressure off, keep creditors happy and get bill collectors off their case.
 

3.   How does debt consolidation using refinancing work?

There are two types of refinancing programs referred to as “Debt consolidation” that simply convert one form of debt into another (“borrowing  from Peter to pay Paul”) as follows:

• Home Equity Loans – this is where you take equity out of your home with a second mortgage or a new first mortgage and use it to payoff unsecured short term high interest debt. See Norm’s Free Tips # 9 – Should I Refinance? – where I review the advantages and disadvantages of this form of debt consolidation.
   

• Unsecured Debt Consolidation Loans – This is where you transfer several credit card debt balances and possibly other unsecured debts into one new unsecured loan account. It could be a formal Debt Consolidation Loan offered to you by one of your credit card companies because of your good payment record and a good credit score. It could also be one of those balance transfer offers you keep getting from your credit cards at a reduced interest rate (you probably receive these offers every week). To be worthy of consideration these new loans must have significantly lower interest rates.

4.   What are the pros and cons of unsecured debt consolidation loans?

This applies to both formal debt consolidation loans and balance transfer deals. If your credit is reasonably good, your income reasonably stable and if you are disciplined and meticulous enough to faultlessly make your debt payments on time and reframe from exceeding any credit lines this could be an excellent way to pay off your credit card debt but make sure you fully understand the advantages and disadvantages.

The advantages are:

• You payoff the debts at a lower interest rate.
   

• The debt remains unsecured which means that you don’t have to hock your house and place it in jeopardy of being lost through foreclosure if you default.

Caution: Like I said above, if you play by their rules (make sure you read the fine print) this could be a way to beat these bandits at their own game. 

The disadvantages are:

• The actual interest rate you get after any bonus period may be too high to make it worthwhile (this depends on your credit score).
   

• Creditors often have unreasonable discretion to increase interest rates (read the fine print).
   

• Normally if you make one mistake (a late payment, overdraw credit) the roof will fall in and your interest will go sky high.
   

• Your credit score must remain good or they will max your interest rate.
   

• There’s always the temptation with their encouragement to borrow any unused credit.

Why do credit card lenders offer these deals?

To take over more of your debt because they know that most people who do this will default and they can raise interest sky high.

5.   How does debt consolidation using an intermediary work?

You engage the services of one of the numerous Debt Consolidation Organizations to pay your debts monthly with funds you provide. The arrangements they make usually extend payout periods and lower interest rates which will reduce your monthly cash requirements for debt service. Sounds good so far but be careful! Many of these companies charge high fees to do this both upfront and monthly. Many of them are what I call “Reverse Collection Agencies” – they set up these payment plans but usually don’t tell you that they also get commissions from the creditors based on how much you pay. And, paying this way normally has a negative effect on your credit score.

Also, don’t be fooled into believing a Debt Consolidation organization is reputable if it refers to itself as a Nonprofit Company. This is often a sham to give them creditability and evade taxes.

6.   What are the pros and cons of using Debt Consolidation Organizations?

Advantages:

• May include some counseling help but their main business is debt consolidation.
   

• They may be able to obtain reductions in interest but not in principal.
   

• You write one check a month which they distribute (pro-rata) to your creditors.
   

• Creditors included in the program will stop chasing you. 

Disadvantages:

• Normally you will have to pay a registration fee and or a monthly fee.
   

• Their purpose is to make money (nonprofit or not) which usually also comes from the kickbacks they receive from creditors.
   

• Their interests are served by accommodating your creditors not you.
   

• There is little regulation or licensing requirements of this industry to protect you from abuse and incompetence.
   

• Many are ill-equipped to help you using untrained counselors who are debt collectors in disguise. 
   

• Some are unethical and even dishonest not apportioning your payments and retaining the funds.
   

• Most do nothing to improve credit and cause additional credit damage.

7.   What are the best Debt Consolidation Organizations to use?

I’m dead against using debt consolidation organizations under any circumstances but if you must, stick with those that are government sponsored or funded because they are subject to some scrutiny and regulation and thus apt to be more reputable and more focused on your needs and interests.

However, be careful; being a non profit company does not mean they are government sponsored or funded. Also, don’t be fooled by the nonprofit label. In many cases it’s just a ruse to make you think they are reputable and that their primary purpose is to help you. Many of these companies, though technically operating as not for profit, disguise their profits with inflated salaries, benefits and other accounting trickery so they can skirt the rules. Be careful; check them out with Better Business Bureaus and your State’s Division of Consumer Affairs or Attorney Generals Office to insure that no complaints have been filed against them. If there are complaints stay away. Also:

• Don’t assume they’re paying your creditors; request that they provide you with a monthly breakdown of the payments they make and make sure you continue to get monthly statements from your creditors to insure that the payments are being made.
   

• Don’t be fooled by their elaborate websites and promotional material in fact this should make you more suspicious of their credibility and their motives.
   

• Don’t be fooled by their claims and be careful; being publicly funded is no guarantee they are not paid by creditors and operating as a nonprofit company doesn’t mean they are publicly funded.
   

• Check them out and find out how they are funded. Ask them point blank and walk away immediately if you don’t get straight answers.
   

• Check the qualifications of the individual counselor assigned to you. Anyone can be a credit counselor no regulation, no license and no education required. No matter how reputable the counseling organization may be, if the counselor working with you is a rookie or just clueless the results he or she obtains for you will reflect it.

8.   Is there any way to determine which companies are unscrupulous?

This is not easy to do; there is no clear cut method to go about it. But, if you must use a debt consolidator here are some other steps I would take to choose one:

• Once again, limit your choices to government funded organizations and to organizations that have been around for at least a few years (remember nonprofit does not necessarily mean government funded).
   

• Limit your choices to organizations you can deal with personally not just online or by phone. I would certainly want to get eyeball to eyeball with the person who I will be entrusting my financial life to.
   

• Find out up front exactly what it is going to cost you for their services and unless you are comfortable with it walk away.
   

• Ask if they get paid by the creditors with whom they set up consolidation arrangements. If they do walk away – your interests will not be their primary concern.
   

• Don’t assume they’re paying your creditors; make sure you continue to get monthly statements from your creditors to insure that the payments are being made.

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