Tips on Debt Consolidation

Not all credit counselors are the same.
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Debt consolidation -- accumulating your credit card and other debt into one low-interest loan with monthly payment -- can help you organize your finances. The real goal of debt consolidation, however, is to lower the total dollar amount spent on your debt by reducing the interest and fees. Beware of today’s version of the snake-oil peddler offering an end to all of your financial woes, and learn how to avoid the crooks that take your money and leave you worse off than before.

Paying for It

Opportunists found a way to take advantage of the credit crunch and debt crisis by offering debt consolidation services that cost you money. Here’s how it works: First, they promise you will pay "less," but what they really mean is that you pay less monthly, because they’ve tacked on a fee to your debt, and extended it out for years. The end result: You’re now out the fee, and the interest charges over the term of the loan add up to more than you originally owed. You would have received better service by contacting the creditors on your own to ask for an extension. Better yet, the Department of Justice's U.S. Trustee Program lists reputable credit counselors on its website (See Resources).

Not Debt Consolidation

Watch out for debt settlement programs in disguise. Some “credit counseling” services indicate that they will negotiate a lump sum payment for all your creditors, and you’ll be free of the debt after 120 days. What actually happens: The service holds your money in its pockets until the creditor "charges off" the debt. (Charging off a debt means that the creditor has deemed the debt uncollectable and may refer it to a collection agency or legal service; it does not mean the debt's forgiven.) By then, the creditor will likely accept cents on the dollar as opposed to nothing, and the credit counselor pays it, but your credit rating is toast.

Another Option

If you own a home, and have paid enough mortgage payments to generate equity, a home equity loan consolidates your debt into one lump sum. Home equity loans bring two main benefits: An interest rate that's usually quite a bit lower, reducing the cost of the debt, and tax-deductible interest payments, meaning you'll get some of that money back at tax time. The downside, however, comes in putting your home on the line. While credit card companies can't take back the stuff you've bought, your mortgage lender can foreclose on your home if you don't pay. When determining if a home equity loan is right for you, be sure you can make the payments. If this options leaves you with less than $100 disposable income at the end of the month, bankruptcy may be a necessary step.

Considering Bankruptcy

Bankruptcy can be scary, but necessary if you don’t see yourself paying your debt in the foreseeable future. Stephen Elias, president of the National Bankruptcy Law Project, attorney, and author of several bankruptcy guides, says that if you have less than $100 in disposable income at the end of the month, you will likely qualify for Chapter 7 bankruptcy. While it usually wipes out most credit card debt, Chapter 7 also requires you to sell off your assets except your home and other necessary assets (on which you’ll have to keep paying). Chapter 13 bankruptcy allows you to reorganize your debt using your assets to determine how much you’ll can pay. Again, credit card debt lands last on the list, and the judge will probably dismiss it. Both types of bankruptcy affect your credit rating for seven to 13 years, but if you can't make minimum payments, your score may already be as low as it gets.

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