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In March 2011, Americans had a total of about $16 trillion in consumer debt.
According to the U.S Debt Clock, the average amount of debt person was $51,960. Yet, the amount saved per family was approximately $7,099. People owe more and save less.
While most of this debt is from mortgages and student loan, part of it was from credit card debt. Credit cards and other unsecured credit can costs you a large amount of money each month in interest payment. This is money that can be used or saved.
Unfortunately, many people use their credit cards on a consistent basis and don’t pay the balance up each month. Many adults do not know how to manage their credit and can easily fall victim to easy credit and high balance.
They fall victim because they disregard the growing balance and the increasing monthly payment. They see credit as something to be used. And they use it, regularly. When they get into a financial situation, where money is tight, it finally hits home and that’s when they need debt consolidation.
What is Debt Consolidation?
Debt consolidation allows a person to reduce the amount of money they have to pay each month. This can be done by either, making arrangements with the creditors or paying off the debt. By reducing the monthly payments, the consumer is able to manage their debts and free up some of their income.
Many Americans are living paycheck to paycheck. There is not money left over after paying bills and debts for saving or investing. When the economy took a fall, many people who lost their jobs, did not have a safety net.
Their accumulated debt, made it impossible for them, with reduced incomes to make payments. Even those who were able to keep their homes and property may have taken a hit to their credit scores because of late payments.
Types of Debt Consolidation
There are three main ways for a person to consolidate their debts. Each one offers a different type of service to the consumer.
Debt Consolidation Companies
Debt consolidation companies can help to negotiate with your creditors to lower your balance and reduce payments. They may be able to get some of the late fees removed and help to settle the account for less than is owed.
Debt consolidation companies will put you on a Debt Management Plan (DMP) or debt settlement or debt negotiation plan which will be based on your monthly income and expenses. This plan will help pay off your debts with some negative effects on your credit score.
If you have bad credit and are unable to get a debt consolidation loan, this plan may be the best option. Through negotiations, the consolidator can reduce your balances. Then you can either pay them off one at a time or make an arrangement to pay monthly through the consolidator.
If you have good credit or property to use as collateral, the debt consolidator may advice you to get a debt consolidation or home equity loan to pay off your creditors quickly. The consolidator would be able to help you determine if you’d be able to save money with a loan.
Debt Consolidation Loans
A debt consolidation loan can be secured or unsecured. A secured loan needs collateral. An unsecured loan is based on your income, credit score and ability to pay.
Debt consolidation loans are offered by banks, credit unions and private lenders. Usually, the interest rates for the bank or credit union loans are lower. If you have a low credit rating, you may have trouble getting approved. If approved, you may need collateral or a co-signer.
If you choose to put up collateral for your loan, understand that you will lose your property if you default. Secured loans are offered by private lenders and some banks. Loans can be made again the value of your property. Due to the size of most debt, you’d need items of high value such as cars, motorcycles or jewelry.
Peer-to-peer lending is available online. These sites allow people to crowdfund a person’s personal loan. As the debt is repaid the lenders receive the principle in addition to the interest. The interest rates on these loans are high and they have a minimum credit rating for acceptance.
Before accepting the debt consolidation loan, make sure that your new payment will be less than what you’re paying now. Depending on the interest rate of the loan, it can be more. Also, if you have not been paying on your debts, make sure you can afford the new loan amount.
Home Equity Loans for Debt Consolidation
If you own your home and have equity, you can apply for a home equity loan. In order to do this you need to have enough equity to cover the debts and good credit.
A home equity loan is a mortgage. You’ll need to prove creditworthiness and the ability to pay. The lender will look at your credit score, income, debt amounts, less what you’ll be paying off, the value of your home and how much you owe on your current mortgage.
If you’ve fallen behind on your payments, have a low credit rating or have too much debt, you may still qualify for a loan. Unfortunately, that loan will probably be at an interest rate that would make the payments higher than your current debt.
Before accepting a home equity loan offer, consider all of the fees and expenses you’ll incur, in addition to the new monthly payment. Make sure you’ll save money after all of the costs are factored in. Remember if you default on your home equity loan, you can lose your house, so you should make sure you can afford the payments before signing the loan documents.
The Benefits of Debt Consolidation
Debt consolidation can help a person manage their creditors and get back on their feet financially. This can help to keep them from losing their property to foreclosure or repossession and keep their credit rating from dropping due to late payments or charge-offs.
There are three major benefits to consolidating your debt:
Eliminate High Interest Debt
The average credit card interest rate is around 15 – 18 percent. If the majority of your debt is from credit or charge cards, then you may be paying a hefty sum of money in interest annually.
Car loans have an average interest rate of between one and seven percent. This can vary based on whether the car is new or used. It also depends on the length of the loan. A typical car loan is 36 months for a used car and 60 months for new.
If you have a bad credit rating when you apply for any type of loan or credit card then you’ll be paying more interest than the norm. Your interest rate may be in over 25 percent for a credit card and 10 percent for a car.
Debt consolidation may be able to help you reduce these payments through negotiations. If you’re using a loan, then this debt would be paid off. As long as the loan’s interest rate is lower than what you’re paying, then you’ll save money.
Reduce Monthly Payments
Many people have hundreds of dollars of their monthly budget allocated for consumer debt, which does not include their mortgage. These payments can make a real dent in their budget and keep them from saving money.
Most credit cards have a minimum payment. This amount is due regardless of the balance. Many times this amount is just a little over the monthly interest. Because of this little is paid towards the principal balance.
Debt consolidation can reduce the monthly payment by paying off the debts with a loan. The new balance should be less, per month, than you’re paying now. If the consolidator is able to get the balance reduced, you’ll owe even less.
If you’re unable to get a loan. The debt consolidator can help make a plan to pay off the debts one at a time. They may also be able to get the interest rate dropped so that more of your payment will be applied to the principal. This will help to reduce the monthly payments as each debt is paid.
If you use the money you save from not paying one debt to pay another, then you may be able to quickly eliminate most of your debts and free up your income.
When you’re having debt problems it can have an impact on your credit score. Credit reporting agencies look at your payment history when calculating your creditworthiness.
One of the first things that happen to many people when they’re having credit problems is that they have trouble making payments. Each late payment incurs a fee. Over time, the payments and the fees add up. This may make it more difficult for you to pay
Late payments are reported to the credit agencies. When you have a number of late payments. Or, if your payments start going over 30 days late, this could have a negative impact on your credit rating.
When you stop paying a bill altogether, then your credit score will drop. If your creditors give up on getting you to pay, they will charge-off your account and report it to the credit reporting agencies.
This charge-off and any late payments will remain on your credit report for seven years. If the company takes you to court and gets a judgment against you, then, the judgment will remain on your credit report for the next ten years.
Since your credit score determines your buying power when it comes to getting a house or a loan for a car, it’s important to manage it well. A debt consolidator can help to get the creditors to report your bill as paid and thereby reducing its impact on your credit. Over time with the debts paid off, your credit score will recover.
The Problems with Debt Consolidation
Although debt consolidation can help people with their debts, there are some problems. Some of these problems are caused by other people or companies and some by you.
Here are some problems with debt consolidation:
Unethical Debt Consolidators
When people are in desperate situations, there are those who will take advantage of them. In the past and in recent years a number of scams have been run which took money from people, claiming they were going to get help with their debts.
Some of these companies were set up and appeared to be debt consolidation companies. Others just claimed to be able to help people remove debt information from their credit report. Both were scams. These scam artists took money from people when they needed it most.
Before working with a debt consolidation company, do due diligence. Check online for complaints and reviews. Check with the Better Business Bureau to review any complaints. No company is perfect so even reputable companies will have complaints. It’s how the company deals with those complaints that makes the difference. You want to see companies that make an effort to please the customer to the best of their ability.
Before you pay any money to them for their services or as part of your payment plan, make sure to check them out thoroughly. If you have any doubts about the company, don’t use them.
Most states have consumer credit agencies that can recommend debt consolidation companies or debt counselors. Many creditors have a list of these companies that they can give you, if you request it.
Unethical debt consolidators have made many people wary of getting help with their debt problems. For your safety, investigate any company you plan to work with.
Everyone Won’t Cooperate With Your Plan
One major problem some people have, occurs when one or more of their debtors won’t accept the plan. This can cause any solution, to cost more than you can afford. When this happens, you and your consolidator may need to consider other options.
If a creditor won’t accept an interest rate reduction proposal, then you may have a hefty interest rate to pay every month. This reduces the amount applied to your principal. This means it will take longer to pay off the debt.
If the creditor won’t stop charging or waive, late or over the limit fees, then your balance will increase every month. You will have to pay any balance that is over the limit, in order to get the payments back to normal and stop fees from accumulating.
If the creditor will not waive fees for paying off a debt early or any other fees attached to the debt, then you’ll have to pay more money. This can reduce the amount of loan funds available or mean that it will take longer to pay it off over time.
It Does Not Stop Bad Financial Habits
Debt consolidation can pay off your outstanding bills and give you a clean slate to work from. Your debt consolidator will help you with figuring out how much money you can afford in debt payments each month. That amount is what will be applied to your monthly bills.
Unfortunately, if you got a loan and paid your debts off in full, you may still have open and active credit cards. You may also have an increased credit rating.
The problem with consolidation is that it can’t stop you from making the same mistake over again. You need to be willing to work on managing your spending and not relying on credit.
If you’re able to do this, after your debts are paid, you’ll be able to save money and still have some money left over to enjoy. If you’re not able to manage your money and spending, then you may find yourself in a similar situation in a few years.
Some people cannot manage their debts on their own. If you feel like you’re unable to get a reign on your spending habits, then you should speak to your consolidator. If you have a compulsion or addiction to shopping you should seek help from a therapist.
Conclusion: Should You Consolidate Your Debt?
Only you can decide if debt consolidation is right for you. However, you can’t do that until you have all of the facts. The only way to get that information is to contact a debt consolidator.
You may decide to fix your debt problem yourself. While this is an option, understand that many creditors will not negotiate with you. If this happens, then you may end up paying the full amount on all of your debts. This will make paying off your debt take longer.
Using a debt consolidator does not guarantee that your debt will be reduced. However, they will work hard to make sure you get the best deal possible. Their goal is to help you pay off your debt and hopefully save some money.
There are many ways to manage your debts, just like there are many ways to get into debt. In order to clean up your credit and improve your financial situation, you need to look at all of your options.
Only after examining all of your choices should you make your decision. Debt consolidation may not be the only option. However, it is a great way to get a new start, by getting some help.