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The Debt Consolidation Process Can Go Wrong
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The Debt Consolidation Process Can Go wrong
Written by Liz Weston, CFP(r) Senior Writer | Personal finance economics, credit scores, Liz Weston, CFP(r) is a personal financial columnist co-host on"Smart Money," the "Smart Money" podcast Award-winning journalist and the creator of 5 novels on financial matters, among them the bestseller "Your Credit Score." Liz has been featured on a variety of national television and radio programs such as the "Today" program "NBC nightly news,"" The "Dr. Phil" show and "All All Things Considered." Her columns are published through The Associated Press and appear in a variety of media outlets every week. Before joining NerdWallet, she wrote for MSN, Reuters, AARP The Magazine and the Los Angeles Times. She shares a home in Los Angeles with a husband, a daughter and a golden retriever that is co-dependent.
Updated Jul 20, 2017 2:07PM PDT
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Daniel Montville knew a debt consolidation loan won't be able to solve his financial woes however, the hospice worker believed it could give him some relief. He had already had a bankruptcy filing in 2005 and was determined not to repeat the mistake.
Montville was able to take out the loan in 2015, but within a year he had fallen behind in his payments as well as the payday loans he got to aid his daughter, a single mother with four children. The payday lenders have almost cleaned out his checking account every time a paycheck came in which left him with a bare minimum of funds to cover the necessities. Then , his daughter lost her job and the tax refund of $5,000 she had promised to him as repayment went instead to helping her children.
"That's the moment I woke up and realized this was a no-win situation," says Montville, 49, of Parma, Ohio. Montville is now paying his creditors under a five-year Chapter 13 bankruptcy repayment plan.
could be a response to a borrower's need however it does not always address the overspending that caused the debt in the first place. Within a short time the borrower is often buried deeper in bills.
"It's simple to fix it," says Danielle Garcia, a credit counselor with American Financial Solutions in Bremerton, Washington. "They aren't addressing the root of the problem."
From the frying pan
The five-year $17,000 loan Montville received at his credit union, for example paid off 10 high rate credit card bills, lowered the rate of interest on the loan from double digits to a mere 8%, and provided a monthly fixed installment of $375. This was lower than what he had been paying on all the credit cards.
What the loan did not do, however, was change Montville's spending habits. Paying off the credit cards only gave him room to make charges.
A portion of the debt resulted due to unexpected expenses like repairs to cars. However, Montville estimates 60% were due to "foolish spending."
"I wanted a TV. I needed clothes. I'd like to go to a movie," Montville says. When he bought a new computer, he noticed only the low monthly payment of $35, not the interest rate of 25%. rate that he was paid. When his daughter fell into financial trouble, he turned to payday loans because his cards were at their maximum.
Now that he is unable to longer borrow -the credit card accounts are shut, and he would need the permission of the bankruptcy court in order to purchase a new carand Montville is now thinking about what he actually wants to purchase versus what he wants to buy. He contemplates whether he could go without a purchase, or postpone it. If he really desires something, he will save for it.
"My current feeling is cash only," Montville says. "Once I have paid cash, nobody can take it from me."
Consolidation is a method is not an answer
Montville's lawyer, Blake Brewer, says many of his clients don't have any idea what their spending amounts are against their income. They assume that their next tax refund or a stretch of overtime will help them catch up, not realizing that they are spending more than they make.
"These people are simply amazed when I sit with them and take out the calculator," Brewer says.
Some of his clients consolidated their debt using a 401(k) loan or a home equity line of credit. They boast of saving money by lowering their interest rates, but they don't realize they're spending assets -- retirement accounts and homes equity which would normally be protected against creditors when they file bankruptcy court.
People seeking debt consolidation also can wind up with , which promise to persuade creditors to settle for less than they're owed. The process of settling debts typically results in an enormous hit on credit scores, but success isn't guaranteed and some companies simply disappear with the thousands of dollars they demand.
Through a credit union or a reliable online lender -- don't have to be a disaster if the borrowers:
Stop using credit cards
Make a commitment to an annual budget
Save for emergencies so they don't need to borrow to pay for the unexpected expenses
Most importantly, their debt must remain manageable, and payable in the threeto five year period of the typical debt consolidation loan. If it would take longer than five years before they can pay the balance by themselves, the borrower must consult with a .
"By the time the majority of people seek help, they're already in too in the hole," says Garcia, the credit counselor.
Liz Weston is a certified financial planner and columnist at NerdWallet the personal finance site, and creator of "Your Credit Score." Contact: Twitter @lizweston.
The post is written by NerdWallet and was originally released by The Associated Press.
Author bio Liz Weston is a columnist at NerdWallet. She is a certified financial planner as well as the author of five books on money, including "Your credit score."
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