Posts Tagged ‘Unsecured Debt’

Debt Consolidation

Debt Consolidation is the most common approach to dealing with debt. It comes in many names and forms. Debt Consolidation, Debt Management, Credit Counseling.

At a basic level, they are all forms of debt restructuring with the promise of lowered monthly payments, and reduced or eliminated interest. On the positive side there are many ways to consolidate debt that work more effectively for different people. When looking into a debt consolidation company, it is best to make sure that they consider strategies that are most suitable to your needs.

Here are some common Debt Consolidation Techniques.

Taking out a loan
This strategy is the most sketchy and unfortunately, one of the most frequently used methods of debt consolidation. The idea behind this is simple. You take out a loan equal to your entire debt, pay all of your loans and then make one ‘easy’ payment a month. The lure of this technique is that the interest rate of the principle loan is significantly lower than the interest of all previous loans, and in some cases, this method is effective.

The Down Side
However, two factors prevent this technique from being completely effective. First, depending on how consistently you have been making your monthly payments, there is a high probability that you will not be awarded a loan. Every time you fail to make the minimum monthly payment on credit card debt, that goes onto you credit rating. More often than not, people who seek debt help are already at the point of having missed monthly payments. And if you are awarded a loan it is usually not enough to cover your entire debt, leaving you in essentially the same situation as when you started.

Beware of Scams
Another problem with loans is that debt, and subsequent debt consolidation have become so common place in American society, the flood gates of Debt Consolidation scams have been blown wide open. If you have missed payments, not only are you penalized in terms of credit rating and interest rates, but you have probably been harassed by your creditors or in some cases collection agencies.

Debt weighs on nearly everybody’s conscience, and harassing calls add fuel to the fire of desperation. If you are suffering severe levels of debt related anxiety, you may be willing to do anything to pay these creditors off. This makes you vulnerable to Debt Consolidation Scams, which are variants of the all too common ‘Advance Fee Loan Scam.’ If you come across a loan company offering guaranteed loans at great interest rates with no credit check required, be wary. Most will probably require a application fee upfront. Many people who have sent money to these companies never hear from them again, or are rejected without refund of this fee.

Using Equity
Equity from your house or other real estate can be used to clear your debt. By using equity, the value of your home or property above its purchasing cost is used against your debt. This method is also known as ‘a second mortgage’. Lending institutions are more likely to offer loans, or larger loans to individuals who offer their homes as collateral.

The good news is, is that you are more likely to be able to consolidate all of your debt into to one lump sum, with a lower overall interest rate.

The bad news is, is if you run into debt again, the lending institution can foreclose on your home. If you are normally very good with money and your debt situation is the result of an extraordinary circumstance, (such as illness, lay off, etc.) then the second mortgage can be a viable method of clearing up all your unsecured debt.

However, if it happened once it can happen again. Not to mention it is not uncommon for people to view credit as income. Once the credit cards are cleared up many people feel it is alright to treat themselves to an expensive gift… on their credit cards! Consider the following testimony;

“When my husband and I married, we decided to pool the money from our wedding registry toward a new home. We bought all of our (household)
appliances through credit. Then we decided to have a child and I took time off work.

During this time, my husband was laid off, and soon we were found ourselves unable to make our payments. We confided with one of my cousins who suggested taking out a second mortgage. We tried this and everything seemed to be working. When I went back to work, we thought that we could pay off the second mortgage in no time, so we bought a second vehicle… on credit.

Soon we were buying a new large screen T.V., new clothes, and even financing a trip on credit. The next thing we knew, we had nearly as much debt as before, and a mortgage to pay. And the added income from my job was not enough to cover the balance.”
- Angela, Houston, TX

While using home equity may seem to be an effective way for some people to consolidate their debt effectively, the is a major hidden risk. Unsecured debt, credit card debt for example, for which payments are defaulted for a sufficient amount of time result in a worst case scenario of legal action on behalf of your creditors. Yes, the worst that can result is a through a court order, your creditor can put a lien on your home so that if you sell it, the money would go to them. If you trade this unsecured debt for secured debt, a home equity loan for example, your house if effectively used as collateral, and if payments on this loan are defaulted, you could lose your house! This was nearly the situation that Angela found herself in. But there was a happy ending to her story. Read on to find out.

Why Not Debt Consolidation?

Debt consolidation is a popular approach to managing a burdensome debt load. When most people use the term “debt consolidation”, they mean one thing. Yet, most of the services that offer debt consolidation define it as something quite different.
Loans – Not Necessarily A Good Idea
A loan for $25,000 at 12% interest with a $400 minimum monthly payment sounds a lot better than 30% interest with a $750 minimum payment – on the surface. This is what many financial institutions bank on.

The problem here is obvious. Not many companies will lend you $25,000 without collateral (like a house or other property). In fact, we’ve found that many of our clients are in financial trouble and do not have access to the credit necessary to borrow a large lump sum. The reality is that if you are behind on your payments, it appears on your credit file, and makes it nearly impossible to secure a loan.

As well, if in fact a loan is secured, we’ve found that for many people this extra loan just adds to their current debt load. In a matter of two to three years, the debt increases to where it was, except with this time with much greater consequences.

Equity – Securing Unsecured Debt
Another variation on “debt consolidation” is based on real estate ownership. For example, if your home is worth more than you paid for it, you have equity, and many banks will lend you money against that equity. This process results in little risk to the lender, because if you default, they can force a foreclosure on your property to recover their money.

There is one major problem with borrowing against your equity. In this case, you trade an unsecured debt for a secured debt. The difference is if you default on an unsecured debt, like a credit card balance, the creditor can sue you and obtain a court judgment against you. And yet, they cannot force the sale of your house.

A secured debt, such as a second mortgage, is a far more serious matter, because you’ve pledged your house as collateral.

The fact is: if you default on a debt that has been secured by your house, you risk losing that home.

It’s a risk that is absolutely unnecessary if you instead consider debt negotiation.