Debt consolidation can be a good way to get your debts under control and eventually paid off. But it’s important to understand what debt consolidation can and cannot do. There are a number of myths about debt consolidation and here are seven of the biggest.
Credit counseling and debt management plans — all of them are identical
Bankruptcy is no big deal
You need a formal debt management program to get out of debt
Credit counseling agencies can get your monthly payments cut by 50%
Some agencies are able to get lower debt management plan payments than others
Your life will be ruined by a bankruptcy
Debt consolidation will always save you money
Credit counseling, debt-management programs - all of them are identical
No, they aren’t. There is both nonprofit and for-profit credit counseling companies though most credit counseling agencies are nonprofits. Or at least the best of them are. Debt management plans will vary depending on the agency or company you choose. Some debt management companies will want to loan you money to pay off your debts. You should stay away from them at all costs. What you want from a credit counseling agency is a debt counselor who will review your finances and help you develop a budget and a debt management plan. You will also want your counselor to contact your creditors and attempt to negotiate reductions in your interest rates – which would save you money and help you get out of debt faster.
Here’s a short video that reports the seven steps to choosing a good consumer credit counseling agency.
Bankruptcy is not a big deal
Don’t kid yourself. If you’re thinking about filing for bankruptcy, understand that it is a big deal. For one thing, a bankruptcy will stay in your credit report for seven or 10 years. It will lower your credit score probably by 200 points. You will find it very difficult to get any new credit for two to three years after your bankruptcy. And when you do get credit, it will come at a much higher interest rate. While an interest rate that’s just 1.5% to 2% higher than normal might not seem like a big deal, it would mean thousands of dollars over the course of a 30-year mortgage. For that matter, a bankruptcy could mean paying more for your auto insurance. Plus, a bankruptcy will stay in your public record for the rest of your life. Ten years from now an employer could see that you had a bankruptcy in your past and decide to not hire you – and there would go that dream job.
You need a formal program to get out of debt
Many people find it easier to get out of debt if they have a formal program but this is a myth because it’s not absolutely necessary. You could contact all of your creditors and negotiate with them directly to get your interest rates reduced and to get any fees waived that you’ve been charged. For that matter, you could sit down and create your own debt management plan in terms of how you could become debt free in a specific number of years
Credit counselors can cut your monthly payments in half
Unfortunately this is also a myth. All a credit counselor can do is contact your creditors and attempt to get your interest rates reduced. This could help but it certainly won’t get your monthly payments cut in half.
Some agencies are able to negotiate lower DMP payments than others
The reason why this is untrue is because the credit counseling agencies have no control over your debts. All one of them can do is negotiate with your creditors. It’s your creditors who are in control of your debts. You could theoretically have four different agencies contact your creditors and they would all get approximately the same answers.
Bankruptcy will ruin your life
As noted above, a bankruptcy will certainly have an adverse affect on your life but won’t ruin it. For example, you may be able to get an auto loan or a mortgage as quickly as two years after your bankruptcy. If you work to get your credit repaired, which means making all of your payments when they are due and maybe getting a secured debit card, you could have your life back in decent shape in three to four years.
Debt consolidation always saves you money
This is more of a half-truth than a myth. Debt consolidation can save you money but not always. The biggest example of this is debt consolidation loans. While one of these loans can be a good way to get your debts under control, it can’t reduce them. It’s just a way to move your debts from one set of creditors to another. You might save some money short-term because you would likely have a lower interest rate but you will pay more money over the long run. For example, if you were to get a home equity loan to pay off $15,000 in debt with a 15-year term at 5%, you’d end up paying $5809 in cumulative interest.
Why less equals less
As you can see from this example you would not save money with a 15-year home equity loan. However, you should be able to save money if you were to get an unsecured loan for that $15,000 for, say, five years. The advantage of an unsecured loan is that it wouldn’t put your house at risk as would a home equity loan or a refi. Unsecured loans are now relatively easy to find on the Internet. There is a new class of loans called peer-to-peer lending. This is where you borrow money directly from an individual or group of individuals with no third parties such as a bank or credit union involved. If you have a good credit rating, you might be able to borrow that $15,000 at around 6%. Of course, if you have a lousy credit rating the loan could cost you as much as 29.99%.