The pitches make it seem so simple: One monthly bill! Cut your payments in half! Slash your interest rates!
When you’re drowning in red ink, debt consolidation can seem like an easy answer. Combining debts can be part of a path to solvency, but there are risks involved.
“There’s nothing that’s easy; there’s nothing that’s painless; there’s nothing that’s harmless,” said Mike Sullivan, director of education at credit counseling group Take Charge America.
That means it’s important to investigate any claims a company makes, get everything in writing, and read the fine print carefully before you sign anything, experts said.
Combining credit card debt onto one low-interest-rate card is one way to help cut monthly payments, but there are often extra costs to consider. Companies sometimes charge a fee to transfer your balance, and some of the best offers have teaser rates that surge after a set amount of time. Hopping from card to card repeatedly can put a dent in your credit score, Sullivan said.
“You’re just moving debt around. It will eventually catch up with you.”
For homeowners, home equity loans are another option for combining debt, one that became very popular during the early 2000s as interest rates dropped. Lower rates can make these a good option – if you can get them. Consumers who are already having trouble paying their bills may not be eligible for the lowest rates. There can also be hidden fees you have to factor into your overall costs, like closing costs, attorney fees, and penalties for paying off the loan early.
The biggest problem with a loan like this is that you’re using your home as collateral. That can be dangerous for a person who continues to lean on the plastic.
“A lot of people who (move credit card debt to a home equity loan) start charging right back on the credit cards, and then they have two debts,” said Chris Dlugozima, a counselor at credit counseling agency GreenPath. “If you don’t pay your credit cards, they can’t take your home. If you have a home equity loan, they could.”
If you’re having trouble even making minimum payments and you’re getting slammed by late fees, a debt management program, offered by credit counseling agencies, is another consolidation option.
These agencies can negotiate on your behalf to lower your rates and get rid of late fees. They collect one payment from you monthly, and then disburse the money to your creditors. They also typically charge for this service, including a startup fee and monthly fees that can add up to hundreds of dollars. For that reason, you should try negotiating with your creditors on your own before you consider this kind of plan.
You also need make sure that you’re working with a reputable agency. Fees so high that you won’t be paying down debt for several months is one big red flag, said Ron Berry, senior vice president of the Council of Better Business Bureaus. Some unscrupulous agencies will direct you to a for-profit financial partner, so be sure to ask who actually will be administering the debt payment plan, he said. If you’re going to do it, as always, “you have to read the agreement very carefully,” Berry said.
Debt management shouldn’t be confused with “debt negotiation,” in which a company takes your payments and holds them in escrow until the creditors agree to accept a portion of the debt. While this can be a viable alternative to bankruptcy, it will still hurt. You’ll have to pay fees to the debt settlement company, and any amount over $600 that your creditors forgive will be taxed as income. Your creditors may decide to take legal action against you while you’re negotiating, and your credit score will likely be severely damaged for years even if you reach a settlement.
Debt consolidation, if used correctly, can help get you out of a sticky situation, but it’s not necessarily a long-term fix, Sullivan said. “The trick,” he added, “is to stop spending” beyond your means.
