A Consumer's Guide to Debt Consolidation

Today, many are saddled with enormous debts, whether it be medical bills, credit card debts or other loans that one becomes unable to repay. As the interest rates rise (or sometimes skyrocket) on these loans, the amount owed often continues to balloon, as in addition to increased interest rates, fees, late charges and other penalties are often tacked on to the already astounding amount of debt one faces. This leaves many at a loss as to what to do, they believe that filing Chapter 7 or Chapter 13 bankruptcy may be their only means of seeking financial relief, however, this is not necessarily the case.

Barely making minimum payments gets one no closer to becoming debt free, and failure to make minimum payments only stands to make one's debt load all that harder to manage, so it is easy to see why so many think that bankruptcy may be their only option if they wish to seek financial relief, but there are other options out there.

What often starts out as a small debt, such as a credit card that has been maxed out with minimum payments so large that they are barely manageable, can quickly spiral out of control into a debt that is almost impossible to get rid of. Interest rates begin to soar, collection agencies begin to call and people do not know what to do or where to turn. This leaves many to think that bankruptcy may be their only option, but this is not the case. Not only is bankruptcy not applicable to certain debts, it can tarnish one's credit rating to a point where it will take years to crawl out of the hole built for oneself.

In recent years, a concept called debt consolidation has been popularized as a means to help get one's debts under control, without the need to file for bankruptcy. However, as with any means of working down debts, there are pros and cons to debt consolidation and there are predatory scammers out there that one needs to steer clear from. With a good understanding of what debt consolidation is, what it entails, how it can assist in working down debts and how to avoid being taken advantage of, one can choose a debt consolidation program that is legitimate and will aid in helping them become debt free far faster than one could by making minimum payments, and without all the associated costs and negative pitfalls of bankruptcy.

Just imagine a credit card debt of $10,000. If one simply makes the minimum payments on this debt, it could take decades for it to actually be paid off. The interest that accrues makes it seem like the debtor is always working from behind and in reality, that is exactly what the debtor is doing. If a debt is paid off by this means, many additional thousands of dollars in fees, interest charges and other penalties are included in this often massive figure.

What follows is a brief guide to the basics of debt consolidation, the pros and cons, as well as how debt consolidation can assist those in financial straights to get their life back in order. This introductory guide also touches on the basics of bankruptcy, what it entails and when it might truly be the best option for an individual to get out from under the weight of debt they face.

What is Debt Consolidation?

In short, debt consolidation is a means by which one can bundle all applicable debts into a single loan. These loans tend to have far lower, or even fixed, interest rates, as opposed to the variety of different rates one is likely to face with their accumulated debts. This makes paying bills a lot more simple and having one's entire debt secured under a single loan with a favorable interest rate allows for more ease in budgeting than trying to manage them all separately.

Sometimes, depending on the nature of one's debt, the lender through which a debt consolidation loan is obtained, may be able to purchase one's debts at a discount, thus lowering the total amount that one owes to begin with. This is especially the case with regard to debts that are far past due or when the consumer is on the verge of bankruptcy. Lenders are reasonable and would much rather see a portion of one's debts repaid than none at all. This can mean, for the debtor, an overall reduction in the principal amount of debt that they owe, making their initial debt load far more manageable under a debt consolidation program.

One often needs to have some sort of collateral, such as a home or car, with which to use to secure said debt consolidation loan. These loans are generally obtained through credit unions, banks, financial service companies or other third-party institutions. They offer a variety of different options and some cover different types of debts. Collateral is not always required, as there are institutions that offer what are referred to as unsecured loans, but these tend to come with higher interest rates than a collateral-backed loan.

How Does Debt Consolidation Work?

Oftentimes, when a consumer reaches the point where their debt overwhelms them and they find themselves unable to manage, they are looking at a variety of different debts with different interest rates. Not only is it confusing to have a bunch of different bills to pay each month, the amount of interest charged on each type of debt often varies. Additional fees are often tacked onto accounts that are past due or “in the negative,” further compounding an already unmanageable problem for the debtor.

In the case of credit card debt, one often faces variable interest rates and the farther behind one gets, the higher the interest rate becomes and the more fees one faces each month. This leads to a ballooning of an already unmanageable debt. As the interest rates increase, one becomes less and less able to manage their financial burden, leaving them no choice but to look for some sort of alternative.

With debt consolidation, one merges all of their debts into a single loan. There are two main types of debt consolidation: student loan debt consolidation and credit card and other loan-type debt consolidation. This article will mainly deal with the second type of loan consolidation, as this is the main type of overwhelming debt that faces most.

Debt consolidation is the obtaining of a single loan that encompasses all of one's debts. Basically, the loan pays off all outstanding loans and then the consumer has just a single loan to manage. This is often far cheaper and more convenient than trying to manage all those different debts, with different interest rates. When one takes out a debt consolidation loan, all their debts are secured under that single loan and a single interest rate.

One of the most appealing things about a debt consolidation loan, aside from its simplicity, is that one's principal debt may be reduced due to the lender being able to purchase one's outstanding debts at a discount. By doing so, this allows the consumer to reduce their overall debt burden, sometimes by a significant amount of money.

Even if the principal amount of debt is not reduced, one does not have to juggle a variety of different interest rates. The loan, encompassing all of one's debt, is provided with a single interest rate. Interest rates on debt consolidation loans are often far lower than the variable rates charged by credit card companies and some even offer a fixed interest rate that will remain stagnant throughout the life of the loan. This makes for more convenience when it comes to paying bills and often a lower monthly payment that is far easier for the debtor to manage.

A single loan allows for easier budgeting and keeps the consumer from falling prey to ever-increasing interest rates which balloon the total debt, even when the consumer is attempting to meet minimum monthly payments. The main idea behind these financial products is to provide a simple means by which individuals can actually manage to service their debts, eventually becoming free from them, not continuing to accrue more and more debt as hefty interest rates continue to be applied to the principal debt.

Like most ways of extending lines of credit, debt consolidation loans tend to fall under two different categories: secured and unsecured. If one chooses to enter into a debt consolidation loan agreement that is considered to be secured, it is up to the debtor to provide some means of collateral to back up the loan. Generally, this is in the form of a home, car or other liquid financial assets. Some debt consolidation companies offer unsecured debt consolidation loans, where the loan is backed by the lending institution themselves. They key difference between these types of loans will most often be expressed in interest rates. Those who obtain secured loans will often, but not always, pay less interest on the debt consolidation loan than those who seek an unsecured loan.

It is important, however, to understand the nature of one's debts as not all debts qualify, or make sense, to put under the onus of a single debt consolidation loan. It is also helpful to point out that not all debt consolidation companies are on the proverbial “up and up,” there are many companies out there that promise to completely eliminate debts or offer services that seem to good to be true. Most of the time, these are scams which only serve to put the individual into further debt. Approaching the concept of debt consolidation with keen understanding and research will help prevent one from being taken advantage of.

Understanding One's Debts

There are two main types of debt: secured and unsecured. One needs to understand the nature of all their debts before entering into a debt consolidation agreement. Not all debts qualify for consolidation. The most commonly consolidated debts are unsecured debts of a variety of different types.

These include the following:

  • Credit Card Debt: This includes high interest bearing credit cards of all types.
  • Collections Debt: This generally comprises bills or other debts that have gone unpaid for a significant length of time, allowing for the original lender to sell the debt to a collections agency who will then seek to get the debt repaid, sometimes in full, sometimes at a discount.
  • Department Store Credit Debt or Gas Card Debt: Store cards and other in-house lines of credit like gas cards are often considered to be unsecured lines of credit and are thus applicable for loan consolidation.
  • Unsecured Student Loans: Not all student loans are unsecured. Secured student loans, such as those by which interest is deferred while in school or paid by the government generally do not fall under the onus of what is able to be consolidated. These unsecured student loans are generally those that are in addition to secured loans, needed to help cover educational costs and that gain interest while the student is still in school.
  • Medical Bills: Past-due medical bills and those that have been sent to collection agencies are applicable for loan consolidation.
  • Past Due Utility or Phone Bills: Past due bills such as phone, electric, water, gas and other utility bills that have been unpaid can be included in most debt consolidation programs.
  • Personal Loans: Personal loans, or loans with which the exact purpose of their use is not defined, are generally offered by banks or other lending institutions. These are often considered to be unsecured loans and the interest rates applied to these loans are often quite a bit higher than a traditional, secured loan such as a mortgage.
  • Court-ordered Financial Obligations: Court-ordered debts, with the exception of debts like child support, can often be lumped into the unsecured debt pool that can then be consolidated through a single loan. This includes debts from unpaid parking tickets and other municipal debts that one can incur. Child support is a unique debt that cannot be consolidated through a debt consolidation company. The means by which these debts are managed and appropriated are different from state to state and while not considered to be “secure” debts, as they are not lines of credit, do not fall under the umbrella of that which can be managed by a consolidation company. Back child support dues, however, like many other types of secure debt not covered under debt consolidation can be mitigated through the filing of either Chapter 7 or Chapter 13 bankruptcy, which will be discussed further in below sections.
  • Back Due Tax Debt: Those who owe a significant amount in back taxes to the IRS are often surprised to find that back tax debt is lumped into the unsecured debt category, allowing these debts to be included in a debt consolidation loan. Some companies require that the amount of back taxes owed be in excess of a certain amount for them to qualify, but for the most part, they are accepted as unsecured debts and can be lumped into one's consolidation plan.

Basically, most types of debt are suitable to be put under the umbrella of a debt consolidation loan. The types of debts described above are the most common forms of debt people face, in particular credit card and medical debt, and debt consolidation is a great means by which to get these debts under control.

However, certain loans like home loans, home refinance loans, boat or automobile loans do not fall under the unsecured debt umbrella. These are considered secured debts. As a result, most reputable debt consolidation agencies cannot lump these into the debt consolidation loan. It is often the case that these secured debts are required, or at least commonly used, as a means of collateral for the lump loan that is provided through debt consolidation.

Many people find it helpful to create a detailed list of all debts owned and use that list to determine if the bulk of their debt falls under secured or unsecured lines of credit. For those whose debts are predominately unsecured, a debt consolidation loan may be the best course of action to getting one's financial life in order; for those who face significant secured debt, bankruptcy may be the best course of action. Understanding the nature and details of one's own debts gives one the information they need to make an educated decision as to how to proceed with their efforts to get their personal finances under control.

Scams to Beware Of

As noted above, there are certain types of debt that cannot legally be lumped into a debt consolidation loan such as child support debt, a mortgage, a car loan, or a loan for a luxury vehicle such as an RV or a boat. These debts are, well, as they are, and thus, cannot be remedied through any other means than by working with the individual lender who provided said loans or through the filing of Chapter 7 and Chapter 13 bankruptcy.

Many people who are in debt do not quite understand the options that are available to them, what does apply and what does not and sadly, there are institutions out there that will prey on these people. What often happens is that they end up with more debt than they started with or with empty promises of helping to eliminate certain debts that institutions do not have the ability to eliminate.

When looking for a debt consolidation company, it is important to do one's research. Ensure that the company has a time honored history of providing real results. Any company that claims that they will be able to completely eliminate any debts, especially those such as mortgages or automobile loans, should be avoided as this is simply not true. These debts cannot be eliminated through debt consolidation, they can only be mitigated through the filing of either Chapter 7 or Chapter 13 bankruptcy, discussed below.

It is true that debt consolidation companies have the ability to negotiate reduced principal amounts, thus lowering the total amount of debt owed, but this only applies to unsecured debts and in special circumstances. Companies who charge high fees and offer promises of getting rid of all your debts instantly are more often than not, scams, seeking to take advantage of people who have nowhere else to turn. There have been many horror stories of individuals trusting in companies that only seek to make their situation worse.

Interest rates on debt consolidation loans should not be variable, nor should they be in excess of the interest rates one is already facing with their original debt. The idea behind reputable debt consolidation loans is to provide debtors with a means of slowly paying off the loan and becoming debt free, not obtaining a loan that will simply mire them further into debt.

While many laws and regulations have been passed as a means to help reduce predatory companies from taking advantage of consumers, some of the onus of making sure one does not fall prey to these scams lies with the individual. Common sense and an understanding of how debt consolidation works, what types of debts qualify for consolidation and so on, leave one armed with the information they need to be able to spot a scam before they fall prey to it.

Remember, if it sounds too good to be true, especially when it comes to claims of getting rid of one's debts completely, it likely is and should, thus, be avoided.

The Better Business Bureau is one of your best friends in the search for a legitimate, quality and reputable debt consolidation company. Those institutions that are backed by the Better Business Bureau have provided quality results for consumers and are watched closely for adherence to regulation and other consumer protection laws. It is advised to choose a company that is backed by the Better Business Bureau, as well as to report scamming companies to them so as to protect other consumers from predatory lending and debt relief schemes.

Companies that charge excessive interest rates or who wish to obtain money from the consumer up front, before any loan or legally binding document are signed, should be avoided. Too often, consumers pony up vast quantities of money to these scamming companies and never see a loan or any sort of debt relief.

Most reputable debt consolidations are for-profit companies as they are making money in addition to helping debtors manage their finances. There has been a spate of debt consolidation scams that work under the onus of being a non-profit institution that not only seek to scam consumers, but to offset and avoid tax liabilities with the government. While most people see non-profit organizations as safe, good things, in the case of debt consolidation, this is often not the case.

Red flags should be raised when looking into a debt consolidation company that has claimed non-profit status. These companies often work under the name of “debt management companies,” and the Federal Trade Commission in the United States has found that many of these companies are moving consumer dollars into for-profit companies and leaving consumers out to dry, so to speak.

There are a few ways that a consumer can help reduce the likelihood of being taken advantage of by a predatory company.

First and foremost, avoid non-profit organizations under the umbrella of debt management companies. Companies that seek upfront fees or hefty commissions should also be avoided. If you find a company that you think may be able to suit your needs, contact those companies you are in debt to and inquire as to whether they work with said agency or not. Credit card companies, collection agencies and other debt collection entities are well aware of debt consolidation and can give you an idea as to whether the company in question is, in fact, legitimate.

Sign up fees, monthly fees, debt servicing fees and the like are also red flags that, while the institution may not be illegitimate, may be taking advantage of consumers and charging them more than is necessary to provide said service. When it comes to attempting to reduce debt, the last thing the debtor needs is to fall prey to unnecessary charges.

Here are some useful debt consolidation resources:

Debt Consolidation versus Bankruptcy

Financial experts often advise that bankruptcy should be pursued only as a last resort. The hit to one's credit and the length of time (generally at least seven years) it takes to get out of the trouble caused by filing bankruptcy makes it prohibitive. Another reason that it bankruptcy is warned against is that there are many other, far more satisfactory, options for reducing and managing one's debt that do not require one to completely ruin their credit and ability to obtain lines of credit for the foreseeable future.

Debt consolidation loans often make less of a negative impact on your credit and your future ability to obtain different lines of credit. While certain debts cannot be managed by a debt consolidation loan, and can be managed through the filing of bankruptcy, it is generally only in incredibly dire straights such as when one may be about to lose their home or other debt that does not generally fall under applicable debts for a debt consolidation loan, that this is the best course of action.

One of the biggest drawbacks of filing bankruptcy is the length of time one's credit score will be affected and the many ways in which it will limit not only purchasing power, but the ability to obtain all sorts of different forms of credit. The process of simply filing for a Chapter 7 or Chapter 13 bankruptcy can also be financially prohibitive.

Chapter 7 and Chapter 13 bankruptcy, the two most commonly filed types by consumers, do have the ability to provide an immediate stay on one's debts, meaning that one's home will not be in jeopardy and much of the harassment one faces from creditors may end, however, it comes at great cost, both literally and figuratively.

Filing for bankruptcy is no inexpensive feat. It costs money to file and often necessitates the hiring of a bankruptcy lawyer in order to get a judgment that is not only fair, but that works for the individual seeking to file for bankruptcy. We all know that lawyers are not cheap to come by, but they are part and parcel to obtaining a proper bankruptcy filing. This means, in addition to the credit score and credit lending hits one takes, they must also come up with the out-of-pocket money needed to hire a reputable lawyer with a history of providing good results for their clients.

With debt consolidation, one does not need to hire a lawyer in order to enter into a loan agreement which will aid in the reduction and eventual elimination of debts. There are certain, extreme cases where bankruptcy is truly the only option, but this tends to be in cases of extreme debt due to secured lines of credit. For the most part, debt consolidation proves to be not only more financially prudent than bankruptcy, but also entails fewer negative “hits” on one's credit score.

Debt consolidation is often the best answer in both the short- and long-term for individuals who are facing a large, unmanageable amount of unsecured debt. When one faces financial struggles which relate to secured debt that requires the additional layers of legal protections offered through bankruptcy, this is likely to be the best option. When one consolidates their debts, as opposed to filing bankruptcy, their credit score is not nearly as negatively impacted, however, this means of debt reorganization is not all that suitable for those who are mired in mortgage, secured or other debts that do not fall under the proverbial umbrella of what a debt consolidation company manages.

Debt consolidation is often less expensive, as there is no need to hire a lawyer or go through complex legal proceedings in a court of law. Bankruptcy, however, offers a means of hope and a road to financial freedom for individuals with a different kind of debt.

This is why, when weighing the options of whether one should enter a debt consolidation loan or file for Chapter 7 or Chapter 13 bankruptcy, it is vital that one have an in depth understanding of their debt, the types of debt they carry, and the amount of debts they owe. Understanding the key differences, the pros and cons, of debt consolidation versus bankruptcy, along with an understanding of one's financial information is imperative to determining which course of actions is best for one's situation.

Debt consolidation is a great way to take many different debts and consolidate them into a single loan with a low or fixed interest rate. This single loan can help one avoid continued interest accrual and actually give one the means to create a budget that will eventually allow them to be debt free. For many people, with the types of debt they are saddled with, debt consolidation is actually a better option for them, both in the short- and long-run, than filing bankruptcy.

It is important that consumers understand what they are getting themselves into and do not fall prey to the fly-by-night companies that offer help that seems to good to be true. The old rule of thumb that, if it seems to good to be true, it probably is, most certainly applies for debt consolidation.

By taking the time to understand what it is and how it works, as well as how to avoid being taken advantage of, one can enter into a quality debt consolidation contract that will allow them to actually work towards a debt free life. Understanding how debt consolidation works, what debts qualify to be consolidated under these plans and how to manage the consolidation program once entered into it is the best means by which one can get their personal finances under control.

In today's unstable economy where debt is piling up on families at an alarming rate, it can be difficult to see that proverbial light at the end of the tunnel. As interest rates rise and debts balloon, simply meeting monthly minimum payments can become difficult, if not impossible. This just furthers the negative debt cycle and leads many to believe that the only way they can find relief is through filing bankruptcy.

A bit of research and a deep understanding of not only the debt consolidation process, but the nature of one's own debts, can help one get on the path to financial freedom and security once again. Debt consolidation is a wonderful means of getting one's debts under control through one simple loan with one low or fixed interest rate, so as to allow the consumer a means of planning and budgeting in a way that will allow them to pay down their debts and eventually be debt free, rather than constantly working from behind, feeling as though there is no end in sight.



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