Do you feel like you’re being nickeled and dimed to death with all of your monthly financial obligations? Maybe you’ve seen ads about debt consolidation where you just pay one time and your debt actually decreases. In this post, we will look at debt consolidation and explore its implications.
Debt Consolidation: What Is It?
In its most basic form, debt consolidation works by combining multiple debt payments into one monthly payment through obtaining either a secured or unsecured loan. That monthly payment is sometimes lower than the individual payments combined, and the interest you pay is sometimes lower as well. You will maintain your access to credit, though incurring more debt increases the likelihood of the debt consolidation failing.
How To Do It: Unsecured
One of the easiest ways to consolidate your debt is to obtain a new credit card that offers 0% interest for a period of time (usually 6 to 12 months). Once you get the card, you can transfer the balance from other credit cards where you are paying high interest to the new card and use the 6 to 12 months to pay down the principal. Of course, that only consolidates your credit card debt. And if you’re already behind on your monthly payments to your credit cards, you are unlikely to qualify for a new credit card. Since credit cards are unsecured loans, this method of debt consolidation can decrease your indebtedness without risking collateral.
How To Do It: Secured
Alternatively, you can take out a debt consolidation loan. There are a number of financial institutions offering debt consolidation loans though almost all are secured loans. That means that you must put up assets as collateral, usually your car or home. If you do not adhere to the repayment plan, you risk losing your collateral. There is an additional danger if your debt consolidation loan comes from the same financial institution that services other loans you have, like your car loan. It’s a hidden danger called cross-collateralization.
You may risk losing collateral that you aren’t aware you have placed in jeopardy. That can happen when your debt consolidation loan has a cross-collateralization clause that lets the lender take other property it has financed if you default on the debt consolidation loan. For example, if you get your debt consolidation loan through the same bank that financed your car, under the cross-collateralization clause, if you default on the debt consolidation loan, the bank could repossess your car—even if the car payments are current.
Debt Management Plans
Some people go to an agency that creates a debt management plan for them and negotiates with the credit card companies on your behalf. It’s important for you to know that agreeing to a debt management plan comes with a number of hidden costs – monetary and otherwise. You will be expected to pay an enrollment fee as well as a monthly fee for each credit card on the plan. Also, most credit card companies will require that an account entering into a debt management plan be closed, so you lose your access to credit. And the fact that you’re engaged in a debt management plan will be noted on your credit report. Most debt management plans run for three to five years, and at least half of clients do not successfully complete the plan.
Negative Tax Consequences
Depending on your financial condition, any money you save from debt relief services such as debt consolidation may be considered income by the IRS, which means you pay taxes on it. Credit card companies and other creditors may report settled debt to the IRS, which the IRS considers income.
Debt consolidation sounds like the perfect solution on the surface, and it may well be your best option. However, you should be aware of all of the implications of debt consolidation before you enter into it. Contact the experts at Burr Law; they will give you the best advice for your particular situation.