In our current economic climate, so many are completely overwhelmed by debt. Student loan debt, mortgage payments, medical bills, auto loans and credit card debt can pile up astronomical sums owed. In desperation, many people turn to debt consolidation as a solution to financially crippling indebtedness. But, before deciding to fight fire with fire, consider the dangers of debt consolidation.
Chris Viale is the president of Cambridge Credit Corp, a nonprofit dedicated to credit counseling. Viale warns that debt consolidation is not an actual fix for most people. “You’re getting symptomatic relief, not a credit cure,” he warns. Viale asserts that 70 percent of American consumers who take out debt consolidation loans, home equity loans, or other lines of credit end up with the same (or more!) debt within two years. Even transferring balances to zero interest credit cards can be problematic.
This depressing statistic is illustrative of one of the primary dangers of debt consolidation. It encourages the very behavior that created the debilitating debt in the first place. Adding yet another creditor to the list of sums owed is completely counter-intuitive if one’s goal is escaping financial ruin. Not only that, if someone has found themselves in the position of needing more money to throw at their bloated debt one can probably infer that their credit rating has suffered. That means loan seekers will not qualify for the attractive interest rates financial institutions advertise. Those rates are almost always reserved for people with extraordinary credit scores.
Let’s look at the dangers of debt consolidation associated with each type of consolidation product.
Dangers Of Debt Consolidation: Home Equity Loans Or Lines Of Credit
Leveraging the equity one has on their home to attain an equity loan or line of credit can seem like a really good idea. It is touted by financial institutions as a quick and easy way to acquire money to pay off other debts and get a tax break at the same time.
But borrowing against one’s home is incredibly risky. The scariest outcome is that debtors who choose this option can lose their home. Diane Giarratano is the director of education at Garden State Consumer Credit Counseling. Giarratano warns that in many cases with equity loans “Some hardship occurs and now they have double the debt and if it’s secured by their home, they could lose it.”
Not only are the stakes high, financial institutions encouraging loan seekers to take larger loans than necessary. “Banks will tell you how much you can borrow,” Giarratano says. “That doesn’t mean you should borrow the total amount, but that’s what people do.”
It is also worth noting that even though equity loan interest is generally tax’ deductible, there are some restrictions. And, even when interest does qualify it may not be enough of an offset to actually benefit the person in debt. The dangers of debt consolidation are very high with this consolidation product.
Dangers Of Debt Consolidation: Balance Transfer To A Zero Interest Credit Card
It may seem like a no brainer way to stop paying interest but usually transferring balances to a zero interest credit card is more of a bait and switch ploy by the credit card companies. First of all, people with less than stellar credit ratings probably won’t qualify for zero or single digit interest rates. And, even if they do, it’s almost always an introductory offer. Look for when the rate ends and what the new rate will be after the introductory offer ends.
Another pitfall inherent to this form of debt consolidation is that the low rate is contingent on meticulously prompt payment. Even one late payment will disqualify cardholders from the low rate. With this type of card, the penalties can be severe for late payments.
The trick to making this debt consolidation trick work is transferring the debt again before the introductory offer ends. “It’s a short-term fix,” Viale says. “The only way it works is if you are really meticulous about paying it and stay on top of it and then move onto another credit card before the low interest rate expires.” But be aware that transferring the balance every six months can also negatively affect one’s credit score. Bait and switch is the biggest one of the dangers of debt consolidation associated with this product.
Dangers Of Debt Consolidation: Consolidation Loans
Consolidation loans promise to simplify one’s life by trading the payment of many bills each month for one large loan payment. Consolidation loans are designed to pay off all outstanding debts and leave the loan holder with only one payment. But, ease doesn’t necessarily mean savings and often one ends up paying more every month than they did with their original creditors.
Banks also often offer more than is needed to pay debts and new debt is acquired while attempting to ease financial hardship. The total of payments is also often considerably more. Falling into the misplaced belief that this product will make things easier is probably this products most common manifestation of the dangers of debt consolidation.
Tips For Navigating The Dangers Of Debt Consolidation
- Don’t borrow more than you need, no matter what banks may offer you.
- Beware of bait and switch introductory credit card offers.
- Do your own calculations; do not depend on the advice of a loan officer trying to sell something.
- Consider nonprofit credit counselling