Taking out a low-interest loan to pay off bills may seem like an attractive way to deal with financial obligations, but there are some important things to consider before consolidating your debts.
If you’re considering debt consolidation:
- Do seek help. If your debts seem too large to manage, seek help from a reputable credit counseling agency, advises Angela Lyons, professor of economics at the University of Illinois at Urbana-Champaign. A counselor can help you learn good budgeting practices and weigh the costs and benefits of debt reduction strategies. Find a counselor through the U.S. Cooperative Extension Service or the National Foundation for Credit Counseling (NFCC), and research companies through the Better Business Bureau and your state attorney general’s office.
- Don’t jeopardize assets without understanding the risks. It is possible to consolidate debts by taking out a second mortgage or a home equity line of credit. Another option is a consolidation loan, but these often require collateral tied to your home or car, notes Gail Cunningham, NFCC spokeswoman. Be sure you can make payments; if you can’t, you risk losing your asset.
- Do fix spending habits. Create a budget your family can follow. “The biggest thing is taking stock and being honest with yourself about what you owe,” Lyons says.
Cunningham says that many consumers, after taking out a consolidation loan, end up with new credit card debt. “[They] begin thinking, ‘It’s not going to hurt me to charge just a little.’ In practice we have observed over the years that people end up a year from now with their debt consolidation loan payment and their bills charged up again.”
- Don’t be afraid to contact creditors. You may be able to work out a more manageable payment plan. But don’t wait until your accounts have been turned over to a debt collector.
- Do ask if a debt management plan is right for you. After reviewing your financial situation, a credit counselor may be able to negotiate with your creditors for lower monthly payments, lower interest rates and waived fees. “It allows the consumer to meet their living expenses in full and service their debt obligations,” Cunningham says. This type of program was appropriate for about one-third of the 3.2 million who sought credit counseling last year through the NFCC, she adds.
- Don’t confuse debt consolidation, debt management and debt settlement. Debt consolidation involves consolidating debt through a loan such as a second mortgage or a home equity line of credit. Debt management involves paying 100 percent of your debt over time, on a schedule that your debt counselor arranges with you and your creditors.
Debt settlement, on the other hand, can be risky and make it difficult for you to obtain credit in the future. “With debt settlement, it’s just like it sounds: You settle your debt for cents on the dollar, and that’s reported to the credit bureau,” Cunningham says. “It’s paid by settlement, which of course signals to the future lender that you did not repay your debt in full.”
- Do understand the costs. If consolidation seems the best choice for you, be sure to understand all the costs involved. In addition to paying interest on the loan, you may be charged points (one point equals 1 percent of the amount borrowed). On the other hand, such loans may provide tax advantages.
This article was originally published as Debt Consolidation Do’s and Don’ts on AmericanProfile.com.