Your 3 worst debt consolidation moves
By MP Dunleavey
The phrase "debt consolidation" has always had a magical ring to me.
As if somehow, someone would have the power to mush my debt into one neat little package, which by some incredible financial alchemy would also then shrink the debt itself -- and I'd only owe a hundred bucks or so.
I know I'm not the only idiot who's had this fantasy, because an entire industry has sprung up to support it: The Debt Consolidation Industry and Covert Sting Operation. Every day, I get at least one piece of regular mail offering me low-interest balance-transfer deals for credit-card debt, or arm-twisting e-mail from unknown credit organizations that scream things like:
"DEBT RELIEF IS JUST A CLICK AWAY!"
"CUT YOUR MINIMUM MONTHLY PAYMENTS BY 50% OR MORE!"
"SLASH YOUR INTEREST RATES DOWN TO ZERO!"
These promises are incredibly alluring to anyone who is caught in the quicksand of having too much consumer debt, and who will believe anything, do anything -- click her ruby slippers (bought on sale for just $400!) three times -- to make it go away. But before you start skipping down some financial yellow brick road to see the Wizard of Debt Consolidation, remember this: Watch out for those flying monkeys.
Three bad debt-consolidation moves
1) The Hard-Money Loan
"The biggest myth about debt-consolidation loans is that they're easy to get," says Scott Kays, president of Kays Financial Advisory Corp. and author of "Achieving Your Financial Potential." If you really need a loan, it's probably because you've already missed a few payments and your credit history has more dings in it than a '74 Ford Pinto.
And that's the problem. Kays says that if you are a credit risk, the consolidator may entice you with promises of an easy-does-it loan, and end up charging you higher interest rates than you're paying now -- as high as 21% or 22%. "Your monthly payment may be lower" with one of these loans, "but you'll end up paying more," says Kays.
2) Debt Consolidators Who Promise to Take Care of Everything
This is the fairy godmother fantasy. This Nice Big Debt Consolidation company comes along and swears they'll make your life soooo much easier. They'll negotiate lower interest rates, reduce your monthly payments -- and all you have to do is make "one EZ payment."
In reality, many debt consolidators build in a fee as part of the monthly payment you make to them. It's usually about 10% of the payment (i.e. about $40 on a $400 monthly payment). They pass along your payments to the creditor -- some debit directly from your checking account -- and get back a 10% to 15% slice that the relieved creditor is only too happy to rebate to the consolidator.
Is it worth paying someone else to do what you can do on your own, i.e. negotiate lower interest rates and stretch out your repayment schedule and pay off the highest-interest debts first?
To desperate ears, this might sound like an ideal solution, especially when you talk to these people and they scare the bejeezus out of you. I interviewed two, Cambridge Credit and Counseling Services and Integrated Credit Solutions. Each offered similar services, and I don't recommend either of them. The senior credit counselor I spoke to at Integrated told me, in grave tones, that it would take me 379 months -- or 32 years -- to pay off my debt. With their services, however, they would "save me 27 years," and I could pay off my debt in just 53 months, or about 4 1/2 years.
Thats funny, because when I plugged my debt into the MSN Money Debt Consolidator -- a less biased source, since they ain't getting no fee from me -- they said I could pay off my debt in 41 months, providing I make slightly higher minimum payments to each card: a total of just $60 extra per card.
Here's another risk with consolidators you should know about: they have been known, in some cases, to make late payments or even miss payments, thus worsening your plight (and your credit record).
After I got off the phone with Integrated, I had to ask myself: Is it worth paying someone else to do what you can do on your own? That is, negotiate lower interest rates and stretch out your repayment schedule and pay off the highest-interest debts first? I don't think so.
3) The Balance Transfer Trap
Low-interest balance-transfer cards are a dime a dozen these days, but remember that those rates only last a few months -- and then you have to switch cards again. The danger is that at some point all this activity begins to show up on your credit report, and you start to look like a bad risk. Then if you get turned down, "you could be left holding the high-interest card you were hoping to dump," says Kays.
If you think you can swing from the balance-transfer vines for a few months, just make sure you formally close all your accounts yourself, and then notify the credit-card company to mark the account "closed at customer's request." "Otherwise, on your credit report, it will look like the creditor closed your account," says David Mooney, PR director of Equifax, one of the biggest credit reporting agencies. Thus making you look like an even worse risk, even when you're doing your best not to be.
Your best debt-consolidation moves
If you own a home and have some equity in it, you have a couple of options that are relatively low in cost. These are pretty straightforward:
Take out a home equity loan. A home equity loan has the advantage of carrying a fairly low interest rate, currently in the high single digits, and what interest you do pay is tax-deductible, Kays points out. Most fixed-rate loans carry a 15-year term and require that borrowers pay an origination fee of $75 to several hundred dollars, plus the cost of an appraisal and title insurance.
Do a "cash-out" refinancing. Another option for those with home equity is refinancing your property for greater than the amount you owe and using the extra cash to pay off debt. You get very low interest rates this way, but you're stretching payments out over 15 or 30 years. The total interest cost over three decades can wind up being pretty huge, so think of this as a one-time-only (if ever) option.
Refinance your car. "Most people don't think of it, but it is a secured loan and you can borrow against it," Kays says. The danger there is that you may run out of car before you run out of debt. It's tough to buy a new car when you owe more than it's worth.
Get a personal loan. If you have reasonably undamaged credit, you may qualify for an unsecured loan. Credit unions (see link to the left) typically offer lower rates than banks, but even there you can expect a rate of 11% or more. Still, that may be a whole lot less than the 20%-plus you're now paying to the credit-card company.
Negotiate better terms. You can do this for yourself easily. Just call your credit-card company and ask them to do it (many customer service people are authorized to reduce rates right there on the phone).
Another alternative. Or you can get help from an organization like National Foundation for Credit Counseling (see link to left). NFCC has branches throughout the country; they are a non-profit, community organization that provides free and confidential debt management advice to anyone who needs it. You can even consult with them over the phone, like I did (see below).
Like other debt consolidators, NFCC gets paid by creditors, so it's in their best interest to work out a repayment plan rather than advise you to declare bankruptcy. Not that you want to be advised to declare bankruptcy, but in certain cases it may be your best option.
NFCC makes no outlandish promises beyond the prospect of a saner financial life, and the possibility of qualifying for their low-rate mortgage program. They also offer low-cost financial planning -- a resource I'm definitely going to look into for a future column. Once I have some finances again, I will need someone to tell me what to do with them!
So whatever happened to
Since writing about my struggles with debt, Ive become religious about paying as much money as I could every month. (Thing was: I still carried my credit cards in my wallet. So my new get-out-of-debt tip would be: Take the cards out of the wallet. Otherwise, you will use them.)
Then those big payments started to have an impact. But I was on a mission. I wanted my debt gone. I turned to debt calculators, talked with friends, and ultimately came up with a two-pronged plan of merciless debt destruction. Operation Enduring Freedom from Debt. First, I took on some extra freelance work that, eventually, would pay me a little bit more than my debt in four big chunks. While I was waiting and working, I decided to consolidate my debt and turned to NFCC as my resource.
Here's the best part of NFCC: 1) They give you a one-hour consultation, by phone or in person, to help you decide if you need a Debt Management Plan. 2) In order to do the consultation, they make you fill out a form that details all your expenses.
Writing down my daily expenses is Personal Finance 101, and I've always found it mildly useful. NFCC advisor Nina Reiss, on the other hand, walked me through an entire year of expenditures. Now THAT was eye-opening. She asked me what I paid per month for things I'd forgotten even were expenses: subscriptions, holiday gifts, underwear, new socks, groceries, birthday gifts, movies (even rentals), my yoga classes, banking fees -- you'd be amazed what you pay just to live a semi-civilized life.
Ultimately, Reiss felt that I was living about $100 a month beyond my means, but that I was paying as much as I could toward the debt on my own. We did the numbers and figured that even with their interest-rate reductions, I could still pay off my debt without their help -- as long as I cut back my expenses so that I was living within my means. So in the end, dear reader, getting out debt boils down to one thing and one thing only (which you and I already knew): elbow grease, peanut butter lunches and living like a more reasonable human being.