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Your debt consolidation choicesBy Debt Consolidation Advisors
Choices
If you find yourself deep in debt, there are three basic strategies for dealing effectively with the problem. They include:
1. Debt Consolidation
2. Bankruptcy
3. Debt Negotiation
We'll approach these options one at a time, so you understand what choices are available to you.


Choice 1: Debt Consolidation
Debt consolidation is a popular approach to managing a debt level that has become difficult to handle. When most people think of the term "debt consolidation", they generally think of one specific definition. What most services out there call debt consolidation can be entirely different!


To begin, what is your definition of debt consolidation. Is it:

A - Borrowing money directly from a bank or finance company in order to pay off other bills all at once. What results is a lower interest rate and a single lower payment.

B - A service offered by non-profit organizations known in the United States as "Consumer Credit Counseling Services", or CCCS. A CCCS company will generally work with your creditors to establish a repayment plan and (hopefully) lower interest rates.

C - Bankruptcy under what is known commonly as "Chapter 13" by which debts are restructured.

D - All of the above.


What did you guess? In most cases, the most common answer is "A". This is what the loans industry has made most of us think debt consolidation is. However, what most people don't realize is that the correct answer is actually "D", or all of the above.


Let's define each of the forms of debt consolidation one by one.


A - Borrowing Money - To be consistent with the previous example on the solutions page, let's say you owe a total of $25,000 in credit card debt. Using a minimum payment strategy, it will take you up to 25 years to pay off that debt, depending on how your credit company or bank compounds its interest.


If you take a loan from a bank or mortgage company to pay off that $25,000 at 12% interest (for example), with a $400 monthly payment, however, you will technically have the loan paid off in nine years. What's more, you'll do this with a lower monthly payment. This all sounds good on the surface, but…


There is a problem. There aren't many lenders who will lend you that kind of money without a good amount of collateral (like a house). In reality, few people actually consolidate through loans because of this. In fact, very few people who find themselves in real financial trouble even qualify to borrow a lump sum like $25,000 in the first place. The truth is, if you have already fallen behind on your credit card payments, it will show up on your credit file. A bad credit file often means your chances of borrowing money are close to nil.


Granted, if you have kept up with your payments until now, you might indeed be able to get a loan, but it may not be enough to solve the problem. What's worse is that many people end up getting deeper into debt this way. The loan often just adds onto their other credit card debt, and they end up back where they started.


Loans can also be dangerous, because the industry is unfortunately wrought with scam operators. When people get behind on their debts, there's often a sense of desperation, and these companies play on that desperation. For example, you've probably seen ads claiming "guaranteed loans with no credit check required", all with superb terms. What's the catch? These particular scams are usually variations of what is called the "Advance Fee Loan Scam". What these scams usually involve are large call center operations wherein operators ask you for an up front payment, which they call an "application fee", amongst other things. Beware of this! If you do send money, you will either never hear from the company again (often these operations shut down quickly and relocate to another state), or they will "reject" your application. Of course, they will keep your application fee, too.


The really sinister point about these scams is that they often work. The fact is, few people who have financial difficulties have the resources to hire a lawyer to chase the scam company down. Plus, a lot of them are too embarrassed to try! This is why if you do qualify, and decide to get what is called a "consolidation loan", please do it in your own city! At least that way, you can look your lender in the eye.


Using Equity
Another variety of "debt consolidation" through loans is based on your home or real estate ownership. Here's how this works: if your home is worth more than you paid for it, you have what is commonly called "home equity". In most cases, lenders who offer this form of loan will gladly lend you money, assuming you are not behind on any other payments. This type of loan can often offer reasonable terms, simply because the bank or mortgage company knows that if you default on payments, they can foreclose on your house.


As an example, let's say you have $40,000 worth of equity in your home, and you find a bank willing to loan you that amount using your home as collateral. This form of loan is also known as an "equity line of credit" or a "second mortgage". Let's say that then you use this loan to pay off your credit card.


Once your cards are paid off, you will be in good shape. The question is, for how long? If you are a very disciplined "money person", and the event that caused your financial hardship (i.e. an illness, job loss, etc) is temporary, you may emerge from this situation with good credit. In effect, you still have the same total amount of debt. But, the advantage here is that it is structured so that you can live with it.


There are drawbacks here, though. Many of Debt Consolidation Advisors's clients are victims of home equity loan programs. How, you ask? Well, because a home equity loan will allow you to pay off your loan completely, it also suddenly frees up your credit cards. Suddenly you may begin to feel free to buy yourself a "treat", purchase that big TV you wanted for $5,000, or freshen up your wardrobe with new clothes. This is not always the case, but many of our clients come to us after such a loan. They find that before they know it, they suddenly owe $15-20,000 in credit card bills, AND a second mortgage they're struggling to keep up with! What results is pure disaster.


The Real Issue
The scenario above does not happen to everyone. But, there is a more important issue at hand when you obtain a home equity loan to pay off your credit cards. With these loans, you are effectively trading an unsecured debt for a secured debt. What this means is that if you default on a credit card balance for long enough, your creditor can only sue you, from which they may possibly obtain a court judgement. In this situation, the worst that can happen is that your creditor can put a lien on your house, so that if you ever do sell, you are forced to pay off the money. This is not good, certainly, but your creditor cannot FORCE you to sell your house. Meaning, if you suffer from a long-term illness or job loss, your house will not be at risk.


The situation is quite different with a home equity loan, however. This is because you've effectively pledged your house as collateral. If you default on a debt that has been secured by your home ownership, you risk losing that home altogether.


Why trade your unsecured debts for secured debts? In most cases, this is definitely not the best move. Yet, lured by low rates and reasonable sounding terms, thousands of Americans fall into this trap every year.


Why trade unsecured debts for secured debts? For most people, this is not the best move to make. Yet countless individuals fall for this trap year after year.


Read on here about strategy number 2: Credit Counseling.

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