Consolidating debt may just be borrowing trouble

Joan Mason

Georgia residents hear and see a lot of advertising targeted to consumers with credit problems.

These companies offer to provide a range of goods and services, from copies of your credit report to relief from creditors. Some of them even offer to fix your credit report altogether.

It’s up to you to know what’s legitimate. When it comes to credit, there are plenty of offers out there that are not legitimate. Some companies that frequently advertise as credit assistance agencies are, in truth, debt consolidation lenders. Instead of helping you develop a payment plan to get out of debt, they encourage you to take out another loan, which will pay off all of your credit card balances.

The simple truth is that when debt is your problem, more borrowing is not the answer. The sales pitch for consolidation loans emphasizes that you‘ll have only one monthly payment to make, and it will be lower than what you are currently paying toward debt. When your monthly payment is less and the interest rate is more, you’re going to pay back the debt over a much longer period of time than without the consolidation loan. You may also end up owing even more than you did before the loan due to miscellaneous transaction fees and other charges.

If you do not own your home, it may be possible to get a good deal on a consolidation loan, if you have a good credit score (720 and above). However, most consumers that seek relief from debt payments have credit issues as well. Consumers with lower credit scores will likely see very high interest rates and fees for consolidation loans.

For homeowners, most financial institutions offer home equity loans and lines of credit. These loans tap into the difference between what your home is worth and how much you still owe on it (your home equity) to secure the loan. The advantage to using home equity is that the interest is tax deductible, unlike interest on credit card debt. However, borrowing against your home equity is not without risk.

If your house should drop in value, you could end up owing more than your house is worth. When you pay off credit card debt with home equity, you're trading unsecured debt (credit cards) for secured debt, which is subject to foreclosure or repossession. If your circumstances changed and you couldn't pay, you could lose your home.

For any kind of consolidation loan to work, you need to break the credit habit that caused you to need the loan to pay off your credit cards. Some people do not have the discipline to stop using their credit cards once they have paid them off. If you don’t change your ways, in addition to having a debt consolidation loan balance to repay, you could end up with high credit card balances all over again. If you truly want to get out of debt, it's probably best to leave debt consolidation loans alone. If debt is your problem, borrowing more is not a long-term solution.

A special thanks to Michael Rupured, Consumer Economic specialist, University of Georgia for this information.



Joan Mason, University of Georgia Cooperative Extenstion agent, Sumter County, can be reached at (229)924-4476.

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