Consolidation loans no quick and easy answer

"I never thought in a million years I would ever be here" and "I can't believe this is happening to me" are the anguished cries that I have heard countless times from clients over the last 30 years. As a Registered Qualified Insolvency Counsellor and credit counsellor, I assist my clients in understanding how they have ended up in my office. More importantly, I work with them so they may not need to be in my office again in the future. Each week we will explore alternatives for consumers that are in debt or are looking to develop more effective money management skills.

Doug and Sue came into my office prepared to share with me, a complete stranger, one of their deepest, and most humiliating secrets. A secret they have managed to keep from almost everyone that knows them. A secret that can be so painful at times, they have even kept it from each other.

Their secret: Doug and Sue were in debt.

Their $30,000 of unsecured debt consisted mostly of credit card debt (the average debt load my clients have on plastic is about $22,000, spread over several cards or credit lines). For years they had been making their minimum monthly payments on time. Sue said they had a Triple A credit rating. However, Doug and Sue were not good money managers. They were not always making the debt payments with their own money. At times, they were borrowing money from their credit cards to make ends meet until they had used almost all of their available credit.

Doug and Sue did not start out their financial lives thinking they would ever need my services. Things happen, though. Doug lost his job due to cut-backs at work. Although he had been job searching for over six months, he had not yet found employment. Doug's E.I. payments had not started yet due to his severance package. However, the severance money was almost gone, having been used for living expenses. Although their income was reduced, Doug and Sue had not scaled back their monthly spending.

Creditors began calling the couple, wanting to know when they were going to get paid. The collectors were becoming more aggressive in their demands for money, threatening action. Sue was afraid the credit/collection industry was going to expose their debt secret to her employer, friends and family. The exasperated couple did not know what to do.

Doug and Sue's situation is not unique. Almost everyone has debts, but very few people talk about them because they are afraid of the judgment of others. People need to be educated that a credit rating is not a reflection of who they are, but simply a credit industry tool. A creditor has a number of options available to try and force a debtor to repay a debt that is owed.

If you become financially overcommitted — unable to pay your creditors as the debts become due — talk to your creditors as soon as you realize things are getting out of hand. Tell your creditors what is happening and ask if they can help you. Creditors prefer to have their money repaid, even if it is going to be delayed, rather than be forced to take harsh measures against a debtor to collect money owed.

Collection policies are not generic in the credit industry, each credit grantor has custom-designed collection policies and procedures. If you have tried to deal with one creditor and they refused to accept your offer, that does not mean all your creditors will be similarly negative. Give your creditors a chance to help you. However, do not agree to arrangements that you will not be able to keep. Doing so may damage the working relationship you are trying to build with your creditors.

One option may be to ask your creditors to freeze your accounts — stop payments and interest charges for a specific time period. This course of action may change the completion date of your loan, but should not affect your credit rating. 

Sue and Doug decided to consolidate their debts several times in the past, only to find themselves deeper in debt each time.

Consolidation loans

Some lenders may offer a consolidation loan to qualified clients. A consolidation loan is a new loan that is used to discharge a number of existing debts. A debtor that is unable to maintain previous repayment commitments usually requests such a loan.

Some advertising encourages credit users to borrow enough money to pay off all their debts and just owe one company. However, there usually is a premium price tag on these loans. The credit grantor may take a second mortgage on your home, demand a co-signer (someone who will guarantee payments on the account on your behalf should you fail to make the payments) or register a security instrument (a lien) on your household goods.

Unfortunately, this is not a perfect solution. Borrowing enough money to cover all outstanding debts and making smaller monthly payments has two consequences: the new loan must be for a longer repayment term and the total interest charges may be increased. A consolidation loan may seem like a quick and easy answer, but for many consumers it can be the beginning of a vicious cycle of borrowing money to pay money. This cycle can be dangerous to your financial health and is difficult to escape from.

Before deciding on a consolidation loan, look closely at the interest rate that will be charged. Compare it to the interest you are now paying on your existing debts. Do you really want to transfer debts that are carrying a lower interest rate or debts that are interest free? 

Some consolidation loans may carry a higher rate of interest, as they are often granted to debtors the lender may consider to be a higher credit risk. If you have a contract that is close to completion, the final payments consist mostly of principal reduction and very little interest. So, if you prepay the existing loan with funds from the new consolidation loan, you are transferring the amount owing to the new debt. You will end up increasing the amount of interest you pay.

More and more banks and credit unions are reluctant to offer consolidation loans that are unsecured. Borrowing money to repay debt may not be the best answer. Many debtors use "debt-free" cards or lines of credit again so the money problems continue to grow.

After consolidation proved a disappointment for Doug and Sue, the couple is finally willing to look at all of their financial options, in detail, before they make another financial commitment. Debt consolidation is one of them.

Next Week: More credit solutions for Doug and Sue.