| Q. The commercials on television make
it sound like a debt consolidation loan will solve all my financial
problems. Are these loans really the perfect way to solve my debt
A. For some people debt consolidation loans can work very
well. For others they may come with disastrous side effects.
Q. How can I determine if a debt consolidation loan is right
A. Start by understanding what a debt consolidation loan
is and how it fits into solving your personal debt situation.
Q. Isn't a debt consolidation loan just a loan where you
get money to pay off your bills?
A. No. In almost all cases a debt consolidation loan is structured
as a second mortgage on your primary residence.
Q. What difference does that make?
A. Most debtors attempting to obtain a debt consolidation
loan face issues with unsecured debt, such as credit card bills.
A second mortgage represents a secured debt. This becomes of
critical importance if things go from bad to worse. With unsecured
debt a chapter 7 bankruptcy can discharge the debt, completely
relieving the individual of the obligation. In the case of
secured debt, such as a second mortgage, even in a bankruptcy
situation, the creditor has the right to seize the collateral
if the loan cannot be repaid. When speaking about a second
mortgage that would mean foreclosure on the property.
Q. I intend to make all my payments, why is this an issue?
A. You may have taken the credit cards with the intention
of paying off the balance each month as well. Good intentions
are fine, but unexpected things happen in life. One of the
most critical issues to analyze before taking on a debt consolidation
loan will be the borrowers ability to weather a financial down
turn. I recommend that anyone taking on a debt consolidation
loan be very comfortable that should they have a health issue,
loss of job or other unfortunate financial surprise that they
would remain able to make the payment for some time on the
new debt consolidation loan. To be even more clear, a debt
consolidation loan means you "bet the house" that
you can repay your credit card debt.
Q. My monthly payment with a debt consolidation loan will
be much more affordable, what is wrong with that?
A. There is nothing wrong with lower payments as long as
you understand the mathematical reasons why the payments will
be lower. Take a hard look at your current debt including the
payments and the interest rates. How long would it take to
pay off the debt in full? Then look at the terms of the debt
consolidation loan. In some cases lower payments result from
a significantly reduced interest rate, in other cases the reduced
payment can come entirely from extending the payoff time to
as long as 30 years.
Q. Aren't the rates of these debt consolidation loans always
A. Absolutely not. In some cases, where the borrower has
good credit and a fair amount of equity in the home, rates
can indeed be close to rates expected for a first mortgage.
In other cases, particularly those with individuals with poor
credit or in case of 125% LTV debt consolidation loans, rates
can soar to over 18%. Depending on your current debt, rates
for these debt consolidation loans can be higher than the interest
rate on the pre-existing debt.
Q. What is 125% LTV loan all about?
A. 125% LTV (Loan To Value) loans allow the individual to
borrow monies beyond the value of their home. For example if
a home is worth $100,000.00 and the mortgage debt on the house
is also $100,000.00, a 125% LTV loan would allow the debtor
to borrow an additional $25,000.00 with the result being the
total debt secured by the house after the loan would be 125%
of the value of the home. While this type of loan opens the
door for some individuals who may otherwise have no access
to money it comes with a price. The interest rates for these
loans typically run much higher that other mortgage loans and
origination fees to set the loan up can be as much as 10% of
the loan balance.
Q. Can anyone get a 125% loan if they need it?
A. No. Only those with good to excellent credit will be eligible.
Q. What if a debt consolidation loan would really cure all
my problems? Are there any other dangers?
A. Yes. The debtor must examine how the trouble began. One
of the most common pitfalls and recipes for the worst of disasters
happens when people take on a debt consolidation loan without
rectifying the true cause of the debt. A typical situation
would play out like this: Individuals get into debt trouble
because they are living beyond their means and supporting their
spending habits with credit cards. A debt consolidation loan
seems to solve things by paying off the debts. Unfortunately,
if the spending habits continue, the individuals find in another
year or two they have run their credit cards up to the same
levels or higher than they were before the debt consolidation
loan. Only this time the equity in their house has all been
used up by the debt consolidation loan. They are unable to
pay either the new bills or the debt consolidation loan and
bankruptcy and foreclosure becomes await them.
Q. What is the best way to avoid this scenario?
A. Find out why the debt has truly accumulated. In a case
of irresponsible use of credit cards, after paying off the
credit cards with a debt consolidation loan, cut the credit
cards up. If you need to have credit cards for rental cars,
business trips or on-line purchases consider secured credit
cards or debit cards. Spending on secured credit cards cannot
exceed a limit based on the value of an accompanying savings
account. Use of debit cards require you have money in an account
in order to use the card.
Q. Is there a way to get a debt consolidation loan that does
not require pledging your house as collateral or a way to get
a debt consolidation loan if you do not own a house?
A. No. You may be able to get an unsecured personal loan,
but unsecured personal loans will always require good to excellent
credit and come with interest rates even higher than debt consolidation
loans. Some people may refer to an unsecured loan as a debt
consolidation loan, but the typical advertising you see on
television or in the newspaper for a debt consolidation loan
refers to one secured by a second mortgage.
Q. Is there any legal difference between a debt consolidation
loan and a home equity loan?
A. Not in most cases. A debt consolidation loan in legal
structure generally does not differ in any way from what one
might call a home equity loan or a second mortgage loan.
Q. Ok, Mr. Doom and Gloom, are there any good points to a
debt consolidation loan?
A. Yes. When debt consolidation loans carry a low enough
interest rate payments can be significantly reduced. Many people
find making one payment can be much more convenient that making
five or ten smaller payments. Even if not the best long term
plan, in the short run longer amortizations available with
debt consolidation loans can help with cash flow.
Q. I have very bad credit and no collateral, like a house
or a car, what kind of debt consolidation loan is available
A. Other than borrowing from friends or family, if you have
very bad credit and no collateral I know of no legitimate financial
entity anywhere that will make you a loan. This is an important
point to stress for two reasons. If you have very bad credit
and no collateral don't bother spending a lot of time and effort
trying to find a loan. I have been trying to find unsecured
personal loans for clients with very bad credit for 10 years,
only to find none. If anyone reading this knows of a legitimate
loan I would be excited to hear about it. Based on my knowledge
of financial institutions, their requirements and the default
rate that would exists on such loans, I don't believe that
anyone who did endeavor to make such loans would stay in business
long. With that said, the second point to keep in mind is not
to expend any money to anyone telling you they can obtain an
unsecured loan for anyone with very bad credit. I have seen
ads where people are attempting to sell lists or in some way
taking an up front fee for find such a loan. In other related
cases credit cards are offered enabling a credit line even
with very bad credit, where in reality the application fees,
annual fees and other miscellaneous fees result with the borrower
essentially paying $250.00 for a $250.00 line of credit. A
new trick gaining popularity are "payday loans" or
auto "title loans" avoid them like the plague. The
hidden interest rates on these loans can be 500% per year!
If you have very bad credit and need money don't make things
worse by falling prey to a scam.
Q. In this context what constitutes very bad credit.
A. While each account and loan request may be judged on it's
own circumstances, a bankruptcy within 2 years or a number
of accounts over 120 days late would probably be viewed very
negatively by someone examining a request for an unsecured
Q. Are there cases where it's not a bad idea to pledge the
house as collateral for a debt consolidation loan?
A. Yes, I can envision some situations, particularly in state
that offers very little in way of homestead exemptions for
homeowners in bankruptcy. In some places the equity in ones
home is significantly at risk whether a debt consolidation
loan is taken out or not. When the writing is on the wall that
a debtor will lose their home unless they can clean up some
of their financial mess, a debt consolidation loan can be the
tool to save a home.
Q. I heard that debt consolidation loans are tax deductible,
is this true?
A. In some cases depending on the cost basis of your home
the interest portions may be tax deductible. Potential borrowers
should check with their tax advisors to explore what portion,
if any, would be tax deductible for them.
Q. If things get better can I pay off a debt consolidation
A. In most cases there is no prepayment penalty with these
loans, but read your documents carefully. Some loans will indeed
penalize you an extra-prepayment penalty fee if you pay the