Consumer debt can get out of hand in any number of ways, especially in an economy which is losing hundreds of thousands of jobs each month. Credit cards, medical bills and a host of other forms of consumer debt are accumulating on a monthly basis for consumers that are using these types of accounts just to keep up with life’s necessities. If monthly debt payments look like they are about to get out of reach taking action, first in the form of learning about available options, is an absolute must.
For borrowers carrying too much consumer debt the relief options include credit counseling, debt consolidation, debt settlement, and bankruptcy. The definition of credit counseling has morphed into an umbrella term covering anything to do with indebtedness while many consumers wish to avoid the stigma of filing bankruptcy, leaving debt consolidation and debt settlement as viable options for struggling consumers. Each strategy has advantages depending on the financial circumstances of the borrower. Additionally, there are some substantial risks, particularly in one of the strategies, which should be understood prior to taking the option.
Starting with debt consolidation:
A debt consolidation strategy allows for a borrower to gather high interest consumer debt accounts including credit cards, into a single account with a lower overall interest payment. A typical debt consolidation would lower the aggregated interest rates on the debt being consolidated, allowing the consumer to either make lower payments or to continue making the same payment which would pay down debt balances at a faster rate. The money remaining after paying the interest charges would is then be directed toward the accounts with the highest interest rates to pay them off first. The progression of excess funds would then target the next highest rate until each account is paid in full.
Debt consolidation, as long as fees could be kept in check, was considered to be a solid financial action because the unsecured credit lines that were rolling into the consolidation were typically covered by another unsecured line of credit. Banks were eager to provide financing which generated fees and, by lowering the interest rates on the accounts, increased the likelihood that the accounts would be paid.
The structure of debt consolidations changed dramatically as credit began drying up in 2007. Since then getting an unsecured line of credit for anything has been difficult, even for consumers with impeccable credit scores. Considering the indebtedness of the borrower in a typical debt consolidation, getting unsecured debt in today’s environment is nearly impossible. Absent access to unsecured lines of credit, the collateral used in this type of debt relief now is most often the consumer’s equity in their home which greatly increases risk in the transaction for the consumer. Even then, with housing prices performing the way they are, finding enough equity in a home to support a consolidation is a relative rarity.
Today, debt consolidation which collateralizes unsecured debt with secured debt is just another term for taking out a second or getting a refi. Should a borrower be fortunate enough to get approval, they are now faced with the biggest risk in taking out a debt consolidation/refi; the fact that the unsecured debt in the form of credit cards and other consumer debt has now been replaced by secured debt, usually the borrower’s home. Should the borrower go delinquent on payments the lender now has an asset to go after and can foreclose on the home, an option which would not be available if the consumer debt had remained unsecured.
Debt settlement is different from debt consolidation in many ways with one of the most important factors being that unsecured debt stays unsecured. The process involves hiring a company experienced in negotiating consumer debt to handle all accounts enrolled in a settlement. The company then acts as the consumer’s interface with all creditors, handling negotiations, payments, and all other related activities.
The debt relief option is by far the most aggressive form of debt relief with the possible exception of a chapter 7 filing, an option reserved for only the most destitute of filers since the overhaul of the bankruptcy code in 2005. Debt settlement provides both short and long term benefits to consumers as highlighted in the recent study out of Southern Methodist University. According to the study, debt settlement provided the greatest amount of welfare to consumer above and beyond all other forms of debt relief.
Those benefits include:
* An immediate cut in monthly payments on enrolled debt of approximately 50%.
* Inclusion in the settlement for credit card accounts, department store debt, medical bills, and many other forms of consumer debt.
* An average reduction in enrolled debt balances of 40 to 60%.
* Payoff of negotiated balances within 48 months.
Payments in a debt settlement are set according to what the borrower can pay and typically remain flexible even if the borrower has temporary struggles during the settlement, a much different situation than having a home at risk due to a setback.
An additional advantage provided by debt settlements is the role they are now beginning to play in the loan modification process. Homeowners carrying too much consumer debt are improving their chances of getting approved for their modifications by integrating them with debt settlements. By cutting their consumer debt payments in half, they look like a much better risk to the lender, having more money to cover their mortgage and everyday expenses.
While no form of debt relief is perfect for everyone, choosing the right option can make a world of difference in the ultimate outcome. Be sure to deal with a company that has plenty of experience in all forms of debt relief and, if applicable, loan modifications as well.
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