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If you’re
drowning in debt, you have no
doubt thought of the b-word:
bankruptcy. And don’t kid
yourself. It happens. You may
eventually get past the point of
no-return where bankruptcy is
your only option.
Bankruptcy is not
a great option. It never was,
but it used to be somewhat
better than it is today.
Bankruptcy is going to scar your
credit, diminish your
reputation, and cause you to
change your lifestyle. It’s a
tough thing to overcome, and,
frankly, some people never do
dig their way back out.
Fortunately,
there is something that may help
you avoid bankruptcy. It won’t
work for everyone, but there are
some people who can use it to
get back on their feet without
ever having to undergo the
trauma and tragedy of
bankruptcy. It’s call a debt
consolidation loan.
Consolidation is
fancy word for “lump together.”
In debt consolidation, all of
your many smaller debts are
lumped together into one large
debt.
You may have
tried to consolidate your debt
on your own, particularly when
it wasn’t so out of hand. For
example, sometimes people with
several credit card balances
will do some balance transfers
to get all of the debt onto one
card at the lowest possible
interest rate. The result: one
monthly payment instead of
several and that single payment
is lower than the several would
be if you added them together.
Not only that,
one large debt is easier to
manage mentally. You aren’t
having to scramble to calculate
how much you truly owe: it’s all
in one place. You know how big
the mountain is that you’ve got
to climb—and that’s the first
step in success. Besides that,
one payment is just plain
simpler. You’re not worrying all
month about making a dozen or
more payments on different
dates—and the exorbitant late
fees that can add up fast when
you miss the due date, even by
one day! You only use one stamp.
And, best of all, you can often
consolidate your many debts into
a debt at a much lower interest
rate. Instead of paying off
several balances at interest
rates that range from 14% to 16%
to 18% to even 22%, you have on
payment and maybe you can get an
interest rate of 12%.
The cool thing
about a lower interest rate is
that it allows you to pay off
the debt sooner. Let’s say you
pay $1,000 every month toward
your credit card debt and $800
goes to interest and $200 to
principal. That means you only
get rid of $200 in actual debt a
month. But with a lower interest
rate, now you still pay $1,000 a
month, but only $400 goes to
interest. That means you’re
paying off $600 of the debt each
month. You’ll pay off the debt
three times sooner—without
paying any more than you were
before.
It’s no wonder
rich people worry about stuff
like interest rates!
But can you even
get a debt consolidation loan?
Would you qualify? That depends.
But if you’re drowning in debt,
you should start hunting them
down! It may be all that stands
between you and the dreaded
b-word
Most debt
consolidation loans come in
three flavors:
The unsecured
debt consolidation loan
means that you get a loan but
the person or organization
lending you the money does not
have any collateral—that is
property that belongs to
you—that they would own in the
event you don’t pay the loan.
This loan is somewhat risky for
the lender. If you don’t pay the
loan, they do not have anything
of value and can only hope to
somehow legally collect from
you.
The home
equity debt consolidation loan
and the mortgage
refinancing both require you
to own property, typically your
home. If you don’t own a home,
you won’t be able to get this
kind of loan. Sometimes you can
get a loan against other types
of property—say you owned
undeveloped land or a yacht—but
in most cases, your house
becomes your collateral.
What is the best
kind of debt consolidation loan?
They all have advantages and
disadvantages.
The unsecured
loan is also known as a
“signature loan,” in that you
get it on the strength of your
signature (and credit report).
You are not putting up any
collateral, so that means the
risk is less for you but most
lenders are going to require
good credit. A person with
crummy credit is just not going
to qualify for many unsecured
loans. If you have good (or
reasonably OK) credit, a good
job, and a stable work history,
it’s possible you can qualify
for this loan. Basically, the
bank or financial organization
is just reorganizing and
repackaging your debts for you.
The downside to
this type of loan (besides the
fact that you need good credit
and a pretty decent-pahing job
to qualify for most of them) is
that the interest rate it
charges is typically higher than
the other forms of debt
consolidation loan. But that
only makes sense—unsecured loans
always charge more interest than
loans based on collateral.
A good candidate
for an unsecured debt
consolidation loan might be a
young professional in a
promising job, a couple of years
out of college, who is starting
to realize that five credit card
payments and a student loan are
more than she can manage. A poor
candidate for an unsecured debt
consolidation loan would be an
unemployed person with no real
job skills and horrible credit.
A home equity
debt consolidation loan
could be thought of as a
flexible mortgage. Your house
becomes your collateral and the
loan amount is based on the
amount of equity you have in
your home. For instance, let’s
say you own a $200,000 home
(that is, you can reasonably
anticipate that your home would
sell for that amount) but you
hold a $150,000 mortgage. The
difference between what your
house will bring on the market
($200,000) and what you’d have
to pay off to the mortgage
company if you sold it
($150,000) is $50,000. That
amount is your equity.
The home equity
loan is good for any amount up
to and including your equity.
But you only use what you need.
Let’s say you have $50,000
equity in your house and you
want to consolidate $28,000 in
debts. You can borrow just that
$28,000. Your home becomes your
collateral and you make payments
to the one loan until your
$28,000 is paid off.
The downside of
this loan is that you have to
own a house to qualify.
Regulations vary by state (so
check out your local laws to see
if you qualify), and you have to
have equity in the house. If you
just bought a house or if your
house has lost value to the
point that you’re “upside down”
in the mortgage (meaning you owe
more on the house than it’s
worth or have a negative equity
value), you won’t qualify.
On the plus side,
interest rates should be lower
than the unsecured debt
consolidation loan (but still
higher than a mortgage). Home
equity debt consolidation loans
are relatively easy to arrange
for those that qualify, have the
benefit of flexibility, and do
not involve all of the paperwork
that one gets involved with in
the third type of debt
consolidation loan.
The mortgage
involves refinancing your house,
which really means you work with
a financial planner to get a new
mortgage. (You are applying for
a new mortgage loan and then
using that money to pay off your
old mortgage and put some extra
cash in your pocket.) At current
mortgage interest rates, this is
generally the most advantageous
solution. Your interest rate
should be relatively low,
especially if you have good
credit. If circumstances
are in your favor, you may end
up being able to pay off the
debt with a loan that is less
than the sum of your old
mortgage and your various
consolidated bills.
Of course, you
need to qualify to make that
kind of loan work. First, you
need to own a house. Second, it
helps (but is not required)
if you are refinancing from a
higher-interest mortgage to a
lower-interest one (that is, if
interest was higher when you
bought the house than it is
today). It also helps if your
house has appreciated in value.
In other words, this loan works
well for people who have a home
that they have owned for a
while. It’s more paperwork than
a home equity debt consolidation
loan and you’ll have to pay some
loan origination and mortgage
fees. However, there are some
situations where this is by far
the best option for debt
consolidation.
But you need to
talk to a financial expert. We
recommend a certified credit
counselor (read more about them
in Article Bank). Online
information is great for
background reading and to make
you aware of what’s out there,
what terminology you’ll run
into, and what kind of options
might be available. But only a
real certified credit
counselor—in your state—can help
interpret your individual
circumstances and your state’s
laws and regulations in a way
that arrives at the right
decision for your unique
situation.
Don’t give up
online research. You need to do
your homework. But don’t reach a
decision on the type of debt
consolidation loan you need
without talking, face to face,
to a real certified credit
counselor.
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