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How Debt Consolidation Can Go wrong
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What happens when debt consolidation goes in the wrong direction
Written by Liz Weston, CFP(r) Senior Writer | Personal finance credit scores, economics, and personal finance Liz Weston, CFP(r), is a personal finance columnist host of the "Smart money" podcast, award-winning journalist and author of five books about finances, which includes the bestseller "Your Credit Score." Liz has appeared on numerous national television and radio programs including"The Today Show, "Today" program "NBC Nightly News," The "Dr. Phil" show, and "All things considered." Her columns are distributed in the media by The Associated Press and appear in hundreds of media outlets each week. Prior to NerdWallet, she wrote for MSN, Reuters, AARP The Magazine and the Los Angeles Times. She lives in Los Angeles with a husband, a daughter and a co-dependent golden retriever.
Updated on July 20th, 2017 at 2:07PM PDT.
Editor: Des Toups Lead Assigning Editor | Student loans, repaying college debt, paying tuition for colleges Des Toups is a former lead assigning editor who supported both the auto loans and automobile loans teams. He has years of expertise in the field of personal finance journalism, examining everything from auto insurance to bankruptcy to couponing and side hustles.
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Daniel Montville knew a debt consolidation loan won't be able to solve his financial woes, but the hospice nurse hoped it would give him some breathing space. He had already declared bankruptcy once in 2005, and was determined not to make the same mistake again.
Montville obtained the loan in the year 2015, however within a year he had fallen behind in his payments and on those payday loans he got to help his daughter, a single mother with four children. The payday lenders have almost cleaned out his checking account every time a check came in and left him with only a small amount of money to pay for necessities. His daughter was fired from her job and the $5,000 tax refund she had promised him for repayment was instead given to her children.
"That's the point at which I realized and realized that this was a non-win scenario," says Montville, 49, of Parma, Ohio. Montville is now repaying his creditors in a five-year Chapter 13 bankruptcy repayment plan.
It can seem like the answer to a struggling borrower's prayer, but it often doesn't deal with the excessive spending that caused the debt in the first place. Within a short time many borrowers find themselves getting buried under the burden of debt.
"It's an easy fix," says Danielle Garcia an expert in credit counseling at American Financial Solutions in Bremerton, Washington. "They aren't fixing the root cause of the issue."
From the frying pan
The five-year $17,000 loan Montville received at his credit union, for instance paid off 10 high rate credit card debts, cut the rate of interest on the debt from double figures to a mere 8%, and provided a monthly fixed payment of $375, which was less than what he had been paying in total on the cards.
What the loan did not accomplish however was alter Montville's spending habits. Repaying his credit cards only gave him room to make charges.
A small portion of the debt stemmed due to unexpected expenses such as car repairs. But Montville estimates that 60% of it came from "foolish expenditure."
"I wanted to own a television. I needed clothes. I'm planning to go to a cinema," Montville says. When he bought a new computer, he realized only the small monthly payment of $35 and not the interest rate of 25%. rate that he was assessed. When his daughter was in financial trouble, he turned to payday loans due to the fact that his credit cards were at their maximum.
Now that he is unable to longer make loans credit -- his credit card accounts have been shut and he'll need the approval of the bankruptcy court to purchase a new car-- Montville is now thinking about what he actually requires to buy and what he would like to purchase. He considers whether he can go without a purchase, or delay it. If he really desires something, he will save for it.
"My impression is that I should pay cash only," Montville says. "Once I pay cash, no one can take it from me."
Consolidation a strategy, not a solution
Montville's lawyer Blake Brewer, says many of his clients don't have any clue how their expenses stack up against their earnings. They assume that their forthcoming tax rebate or a stretch of overtime will enable them to catch up, without realizing that they are spending more than they make.
"These people are simply shocked when I sit down with them and pull out a calculator,"" Brewer says.
A few of his clients have consolidated their debt using the 401(k) loan or a home equity line of credit. They are proud of their savings money by lowering their interest rates, however they don't realize they're spending funds -- home equity and retirement accounts which would normally be protected by creditors during bankruptcy the court.
Anyone who is looking to consolidate debt might end up with a debt settlement , which promise to persuade creditors to settle for lesser than the amount they're due. Debt settlement typically causes significant damage to credit scores, however the success of the process isn't always guaranteed. Some companies simply disappear with the thousands of dollars they demand.
Through a credit union or a trusted online lender It doesn't have to be a disaster if borrowers:
Stop using credit cards
Make a commitment to an annual budget
Reserve money for emergencies so that they don't need to borrow to pay for unexpected costs
In addition, their debt must be manageable and payable within the three- to five-year term of the typical loan. The debt consolidator loan. If it would take longer than five years to pay off the debt on their own, borrowers need to consult with a .
"By the time that most people look for assistance, they're already in too deep," says Garcia, the credit counselor.
Liz Weston is a certified financial planner and columnist with NerdWallet which is a personal finance site, and the author of "Your Credit Score." Email: Twitter @lizweston.
This piece originated from NerdWallet and was first published by The Associated Press.
(image: https://i.ytimg.com/vi/auXpZXnegAw/maxresdefault.jpg)Author bio Liz Weston is a columnist at NerdWallet. She is a certified financial planner as well as the author of five money books, including "Your credit score."
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