An insider's guide to debt consolidation
Get on top of your debt
Matt Villano
Matt Villano is a freelance writer and editor who contributes regularly to The New York Times, San Francisco Chronicle, Sunset, Coastal Living and TravelChannel.com. He recently mortgaged his first house in Healdsburg, Calif.
Meet the Frosts. They're in over their heads.
"Debt is as American as baseball and apple pie, but debt consolidation, refinancing, and other tools can help you manage it."
Thirty-somethings Charlie and his wife Charlene (not their real names), live in Portland, Ore. Together, they pull in around $90,000. However, between mortgage payments, student loans, and daily living expenses, the Frosts are paying out roughly $6,000 a month—and that’s not including their astronomical utility bills (sometimes as much as $500 a month) and day-to-day credit card expenses that can total another $1,500 per month. Add it all up and you can see that even though the Frosts make a good living, they're living it in the red.
And they're not alone.
In a society built on borrowing, debt has become as American as baseball and apple pie. For most of us, there are two kinds of debt: mortgage loans, which most of us pay monthly, and non-mortgage debt, which includes credit cards, car loans, and just about everything else.
Considering that each of these loans has a separate interest rate, the more debt we incur, the more interest we must pay. The more interest we pay, however, the harder it is to pay bills in full.
In an effort to get on top of this cycle of debt, many Americans try to consolidate their number of creditors. By lumping payments together, it's considered much easier to handle disparate payments each month. Still, it is no panacea — one false step or missed deadline can actually make matters much, much worse for borrowers trying to get out from under their mountains of debt.
The safest way to consolidate debt is with a loan from a family member who charges fixed interest and won't penalize for lateness. Barring this, however, another form of debt consolidation is for borrowers to take advantage of promotional Annual Percentage Rate (APR) deals from credit card companies.
These deals offer percentage rates as low as 2.9 percent for a fixed period of time. The downside: one late payment can send the APR through the stratosphere to a default rate that's usually at least 20 percent—and the new minimum monthly installment requirements might be higher than the individual monthly payments.
Another popular method of debt consolidation is to take out a personal loan from a bank. These loans usually range in size from $3,000 to $10,000, and are given at fixed interest rates for a fixed amount of time. The downside: Personal loans are unsecured and can have higher interest rates than secured loans.
Increasingly, borrowers are consolidating loans another way: by refinancing a mortgage. Refinancing is essentially paying off your existing mortgage and taking out a new one. The process, which is available only to certain homeowners, enables borrowers to draw cash on the equity they have accumulated in a house.
While this may make good strategic sense, in reality, it can be somewhat challenging to put into practice. First, depending on where you live, it may be difficult to refinance if the recent housing slump damaged your home’s equity. Second, by consolidating debt through refinancing, you are taking shorter term unsecured debt and securing it with long-term debt using your house as collateral. Most financial experts say it’s rarely wise to secure your unsecured debt this way. Considering what you could lose if you fail to make your payments, you may be putting too much at risk.
Perhaps the safest way to consolidate debt is with the help of a credit counselor. These experts work with creditors to lower interest rates and establish payment-reduction strategies for borrowers who are feeling the crunch. You might have to pay a monthly service fee, but these services have proven that they can help borrowers eliminate debt—sometimes in as little as three years.
For a list of accredited credit counselors, contact the Association of Independent Consumer Credit Counseling Agencies (www.aiccca.org).