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Chapter 4: Credit Card Debt Services

Credit Card Debt Consolidation

The term debt consolidation is used by companies offering debt management, counseling, debt consolidation, negotiation, or settlement services. These firms are guilty of using this term to confuse the consumer and to “uniquely position” their firm. It can mean
1) an approach like the debt management and debt counseling services where the monthly amount owed to each credit card bank is paid out of your lump (consolidated) sum payment to the agency, or
2) an approach where your monthly lump sum payments are not disbursed to your credit card accounts, but rather accumulated to enable a negotiation or settlement for less that 100 percent of the debt, or
3) a debt consolidation loan.

Credit Card Debt Consolidation Loans

A debt consolidation loan comes as a secured or an unsecured loan instrument.
A secured debt consolidation loan—a home equity loan—takes an interest in your home should you be unable to pay off the loan. If your credit rating is good you can get a secured debt consolidation loan at a low interest rate. If your credit rating is less than good, the interest rate will be higher and the terms of the loan will be more stringent, putting your home equity at greater risk.   You can take out or use your existing home equity line of credit, or you can apply for a formal debt consolidation loan secured by your home equity.  The former is the better option.  In lean months you can make a minimum payment, rather than one higher, uniform monthly payment.
An unsecured debt consolidation loan will have a higher interest rate than a secured loan. If your credit is less than good, an unsecured loan will be more difficult to get and probably not worth the trouble.  The payment will be as high as the total payments you are making now.

With a debt consolidation loan you pay off your high interest credit card debt with the proceeds from a low interest secured loan. With this loan more of your payment goes to principal instead of high credit card interest. Your interest payments are tax deductible if it is a straight home equity line of credit.  With the right loan, you have the flexibility of paying the minimum principal amount in tight months or additional principal in other months when you can afford it.

With a secured consolidation loan, you put your home equity at risk. If you cannot make the monthly payments, you could lose your home. That is why many financial advisors advise against converting an unsecured loan such as a credit card debt to a secured home equity loan.  On the other hand with an unsecured consolidation loan, you may not make a net gain in your credit card debt because the interest charges are still high.

Do the math. Calculate your payments before and after a consolidation loan. Factor in the tax savings from a secured loan. See if a higher interest unsecured loan makes any sense at all.
A good debt reduction strategy is to combine a consolidation loan with a debt negotiation/settlement strategy.  If you are behind in credit card payments, you can or have your attorney offer a lump sum payment on a reduced principal amount.  The lump sum is more attractive to the creditor  than the promise of you making monthly payments on a reduced principal. With a secured loan at low interest your credit card debt is paid off at low interest, and your credit rating does not suffer.

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