Budget Basics
Consolidation is only first step
Fees can bite into gains made on credit card debt
By Elizabeth Lazarowitz - New York Daily News
Posted on Thu, May. 10, 2007
NEW YORK | The pitches make it seem so simple: One monthly bill! Cut your payments in half! Slash your interest rates! When you're drowning in red ink, debt consolidation can seem like an easy answer. Combining debts can be part of a path to solvency, but there are risks involved.
Combining credit card debt onto one low-interest-rate card is one way to help cut monthly payments, but there are often extra costs to consider. Companies sometimes charge a fee to transfer your balance, and some of the best offers have teaser rates that surge after a set amount of time. Hopping from card to card repeatedly can put a dent in your credit score.
For homeowners, home equity loans are another option for combining debt, one that became very popular during the early 2000s as interest rates dropped. Lower rates can make these a good option - if you can get them. Consumers who are already having trouble paying their bills may not be eligible for the lowest rates. There can also be hidden fees you have to factor into your overall costs, such as closing costs, attorney fees, and penalties for paying off the loan early.
The biggest problem with a loan like this is that you're using your home as collateral. That can be dangerous for a person who continues to lean on the plastic.
If you're having trouble even making minimum payments and you're getting slammed by late fees, a debt management program, offered by credit counseling agencies, is another consolidation option.
These agencies can negotiate on your behalf to lower your rates and get rid of late fees. They collect one payment from you monthly, and then disburse the money to your creditors. They also typically charge for this service, including a startup fee and monthly fees that can add up to hundreds of dollars. For that reason, you should try negotiating with your creditors on your own before you consider this kind of plan.
You also need make sure that you're working with a reputable agency. Fees so high that you won't be paying down debt for several months is one big red flag, said Ron Berry, senior vice president of the Council of Better Business Bureaus. Some unscrupulous agencies will direct you to a for-profit financial partner, so be sure to ask who actually will be administering the debt payment plan, he said. If you're going to do it, as always, "you have to read the agreement very carefully," Berry said.
The council's Web site, bbb.org, lists many licensed credit counseling agencies, along with their complaint and resolution records.
Debt management shouldn't be confused with "debt negotiation," in which a company takes your payments and holds them in escrow until the creditors agree to accept a portion of the debt. While this can be a viable alternative to bankruptcy, it will still hurt. You'll have to pay fees to the debt settlement company, and any amount over $600 that your creditors forgive will be taxed as income. Your creditors may decide to take legal action against you while you're negotiating, and your credit score will likely be severely damaged for years even if you reach a settlement.
After a decade of getting himself buried under a mountain of debt, Long Island resident John Sherman decided that was the only way to dig himself out.
In the late 1990s, Sherman was recently divorced and bringing in a respectable $70,000 a year working as a computer programmer. But the 61-year-old was also burning through his paycheck every month and frequently whipping out the plastic for things like dinners out and vacations. His credit card debt rose to $35,000.
"I saw the debt was going up," Sherman said. "I'd make the minimum payment, figuring: 'I'll double up on the payments and take care of this - later.'" Even as his debt mounted, credit was easy to find. He bought a $50,000 boat, financing all but $10,000 of it.
He got laid off in 2001 and then worked as a freelance consultant. But by 2003, work was scarce, and paying the bills got harder. He tried running a business selling other people's stuff on eBay for commissions, but only ended up racking up another $20,000 in debt on as many as 12 credit card accounts and borrowing from his 401(k).
To get himself back on track, he set up a debt management plan in 2004 with Consolidated Credit Counseling Services, which negotiated his credit card interest rates down to about half of what they were originally. The plan has let him chip away about $10,000 of his massive debt. He also recently sold the boat. He has since landed another full-time programming job, but he's avoiding credit and hopes to be rid of his debt in about 5 years. His progress "is a bit of a relief," Sherman said. "But I wish I'd never gotten into debt in the first place."
