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Wednesday, February 23, 2011
Wednesday, February 9, 2011
How Does Debt Consolidation Work?
The theory behind debt consolidation is that all of your unsecured debt, such as credit cards and personal loans, are bundled up into one debt, payable to one creditor. The new consolidation loan would be used to pay off the smaller original debts at a lower interest rate. The benefits are that debt consolidation is convenient, the monthly payments are usually smaller, and you may save money in interest paid over the long haul. At least, this is what a debt consolidation company will tell you.
Debt consolidation usually comes in three forms: consolidation loans, home equity loans/home equity lines of credit, and credit card balance transfers. A consolidation loan is obtained at a bank, credit union, or consolidation loan company. A home equity loan is obtained at a bank or credit union, and your home is used as collateral to secure the loan. You can also, get a tax deduction for interest paid on a home equity loan. With a credit card balance transfer, you are essentially, moving a credit card balance from a high interest credit card to a lower interest credit card.
The Downside of Debt Consolidation
Debt consolidation is not really all that it is cracked up to be, for the following reasons. Most people who take out consolidation loans end up incurring more debt. This is because the original problem of uncontrolled spending and not saving, goes unaddressed. Furthermore, debt consolidation is nothing more than robbing Peter to pay Paul. The original debt is not eliminated, but rather it is moved from one creditor to another. If you are fairly disciplined about paying bills and monitoring your spending, then debt consolidation may work. Don’t fall into the trap of running up credit card debt again after paying credit cards down with a debt consolidation loan.
When seeking a debt consolidation loan, shop around with credit unions and banks that have good reputations. I don’t recommend obtaining a consolidation loan at a company that specializes in debt consolidation, because these companies tend to charge excessive fees. Also, if you have a very high debt to income ratio or bad credit, you might not qualify for a debt consolidation loan. In order to get a debt consolidation loan at a low interest rate, you must have a very good credit rating. Some companies offer unsecured consolidation loans, but the interest rates are higher in comparison to secured consolidation loans.
With a home equity loan, the value of your home and the equity you have built in it is used to pay down your debt. The problem with this, is that you will have turned unsecured debt, into secured debt. Your home is used as collateral in the event that you default on the loan. If some unforeseen circumstance occurs in your life and you default on the home equity loan, then the home is at risk of foreclosure. If you do choose to go this route, crunch the numbers to find out if it is really worth it. A home equity loan or line of credit that is drawn out over 15 or more years, can result in a higher overall interest payment than anticipated.
In the case of credit card balance transfers, the credit card companies will lure you in with teaser interest rates. Consumers are sometimes offered 0% interest rates on balance transfers. This interest rate is a short lived introductory rate and once it expires, the rate is hiked up to a higher interest rate. If you are good at keeping up with deadlines, you could transfer the balance to yet another credit card before the teaser rate expires. If you aren’t able to transfer the balance for some reason, you would be stuck with the higher rate of interest. You should also be aware of any fees charged in connection to the balance transfer. Also, if you miss a payment this could cause the interest to increase. Again, it is important to crunch the numbers to see if this is worth the time and effort. If your credit is already shot, then a balance transfer is probably not a viable option.
Alternatives to debt consolidation are consumer credit counseling service, debt settlement, and bankruptcy. You could also call up your creditors to see if something could be worked out to get your interest rate and monthly payments more manageable. If you pay your debt without a consolidation loan, work on paying down higher interest rate debts aggressively. Once the higher interest rate debt is paid, then you can focus aggressively on lower interest debt. The bottom line with debt consolidation is that you have to be ready to change your habits and work out all the figures to see if it is worthwhile. Cut up your credit cards and stop overspending after the debts are paid off, so that you won’t repeat the cycle of debt.
Copyright 2011- www.thewhimsicalmusingsofsusan.com
Friday, February 4, 2011
How does Debt Settlement work?
A reputable debt relief company that offers this type of service will typically analyze each client’s financial situation on a case by case basis. The client will have to bare all, when it comes to how much debt he or she is really in versus monthly income. If the client qualifies for the service, the debt relief company will recommend that the client stop paying the creditors (if the client hasn’t already). The money that the client would have paid to creditors, would then be deposited into an escrow account until enough money is saved up to make either a lump sum payment or installment payments to creditors. The debt relief company would also contact the creditors and negotiate with them for lower interest payments and/or to reduce the amount on the outstanding debt. In many cases, the debt relief company may be able to eliminate 50% or more of the debt.
The Downside of Debt Settlement
As with many things, there are pro and cons. When people agree to these services, they are not getting them for free. I am not averse to companies making a profit. However, a prospective client can expect to pay 10% -30% of the amount of debt that is wiped away by the debt relief company. For example, a client has a total of $50,000 in credit card debt. The debt relief company negotiates a settlement with the client’s creditors for $25,000. Half of the debt is gone, but the debt relief company charges 30% of the amount that was reduced. Therefore, the client ends up paying $7,500 in service fees to the debt relief company.
Please be aware that under the FTC’s new regulations, for profit debt relief companies are no longer allowed to charge up front fees for their services. The debt relief company must demonstrate that work is actually being done on the client’s behalf before any fees are charged. Non-profit debt relief companies are allowed to charge up front fees, which tend to be very reasonable (about $75 or less).
Debt settlement will almost certainly hurt your credit score. When current creditors and prospective creditors see settled debt on your credit report, may be rated as a credit risk. The debt relief company must disclose how debt settlement will affect your credit score.
The debt relief company should also explain what the tax ramifications are for settling debt. It is possible that you will be on the hook for the difference between what the original debt amount and the final settled amount is. For example, the debt settlement company saves you $15,000, off an original debt of $30,000. You might be responsible for taxes on the $15,000 saved.
Just because a debtor is working with a debt relief company, doesn’t mean that the creditor won’t turn around and sue the debtor. Creditors that can’t communicate with debtors, may get upset when the debtors stop communications and payments. The creditors may decide to take legal action up to and including lawsuits and garnishments. If a debt relief company doesn’t disclose this to you when you are deciding whether to use their services, then it’s a bad sign.
Debt settlement services are useful for someone who does not like to research, make phone calls, or negotiate with creditors. It puts the consumer at a disadvantage though, since it takes away decision making power. Almost everything is left in the hands of the debt relief company, which is potentially dangerous. The consumer should always be knowledgeable about any business undertaking to avoid getting the short end of the stick.
Do the legwork and negotiating with creditors on your own. If you aren’t paying your debts, the creditors may be willing to work with you to get something out of you, rather than nothing. If you do go this route, request in writing that your creditor reports that the debt is “paid in full” instead of “settled” on your credit report. A credit report of “paid in full” looks much better on your credit score than, “settled”. Just make sure that all of the terms are agreed to in writing. Getting things in writing will also protect you from future legal action by creditors. There are also do-it-yourself debt settlement companies out there that can assist you. Doing the legwork yourself, will save you lots of money if done properly.
You can also try enlisting the help of Consumer Credit Counseling Services. A certified counselor will assess your situation to see if you qualify for a debt management program. Most of the time, consumers still end up paying the principal balance of outstanding debt. CCCS usually negotiates lower interest rates for the consumers, and help to set up a repayment plan. You can find a Certified Consumer Credit Counselor through the National Foundation for Credit Counseling by going to www.nfcc.org.
Bankruptcy may be another option if you owe more money to creditors than you possess in assets, with very little ability to repay creditors (insolvency). Bankruptcy proceedings fall under the jurisdiction of the federal court system. The types of bankruptcy available for individuals are chapter 7 and chapter 13. Once a bankruptcy is filed, all lawsuits, garnishments and contacts from creditors are put on hold. Keep in mind that your credit rating will be ruined for 7- 10 years after bankruptcy. Also, bankruptcy does not necessarily wipe away all debts, such as taxes, student loans, or debt incurred through fraud and criminal restitution. Bankruptcy may be the only option available for many people, and the best way to find out if it is for you is to consult a licensed, experienced bankruptcy attorney in your state.
In closing, the services offered by debt relief companies may beneficial, if the customer is dealing with a trusted and reputable company. It is really up to the consumer to roll up those sleeves and do the necessary work that it takes to educate oneself on what he or she is getting into. There are honest debt relief companies out there but the consumer needs to discover them or get recommendations from satisfied customers. The smart consumer would check the reputation of the company with the Better Business Bureau, the state attorney general’s office, and the FTC to see if any complaints or lawsuits are filed against the debt relief company. A bad financial situation could go to worse if, the consumer does business with an unethical debt relief company.
Copyright 2011- www.thewhimsicalmusingsofsusan.com