Budget Basics

Over the last decade, Larry Williams, 46, and his family have lived a good life on a middle-class budget. They've vacationed in hot spots across the country and bought shiny, new cars and matching appliances for their two-story colonial in a private New York community. The only problem is they purchased these goods and luxuries courtesy of American Express, Visa, Sears, and other lenders. A lead agent at an investigative firm, Williams figured he could handle the spending splurges since he earns a decent salary. But somewhere along the way, his finances started spiraling out of control and by the time he sought help, he had more than $50,000 in credit card debt.

"This was years of accumulation of debt. For some time, I ignored the problem. In January 2005, I finally concluded that I needed help,"says Williams. "I considered bankruptcy, but that was not a viable option for me. I figured, since I bought the goods and used them, the right thing for me to do is pay for them. I just needed to decide how I would get out of debt."

However, many credit counseling organizations are paid by creditors to collect from you. In an industry that has very little regulation, there's room for unscrupulous companies to prey upon your vulnerability. This has been so pervasive that the U.S. Senate Permanent Subcommittee on Investigations released a report April 13, 2005, that examined the credit counseling industry and exposed abusive practices committed by certain credit counseling agencies. Likewise, on Oct. 14, 2003, the Internal Revenue Service, Federal Trade Commission, and state regulators issued a consumer alert for those seeking assistance from tax-exempt credit counseling agencies. To alleviate any difficulty, try going with larger, more reputable companies such as Consolidated Credit Counseling Services (www.consolidatedcredit.org) and the National Foundation for Credit Counseling (www.nfcc.org).

Debt consolidation loans, considered the only true form of debt consolidation, are offered by a bank or through a balance transfer offered by a credit card company. The benefits are significantly lower interest rates and better payment terms. Also, the debt remains unsecured, meaning that you don't have to put up any collateral, such as your home.

Equity financing, on the other hand, pays off your debts using a loan against the value of your home. This method offers lower monthly payments because of the lower interest rate and longer payout terms. If your current home is worth $200,000, for example, and you have $50,000 in equity, you can do one of two things -- refinance or take out a second mortgage. It is only a good idea to refinance if the new interest rate will be substantially lower than your current one. You can pay off all of your credit card debt and other bills and have the added bonus of saving more money since mortgages are tax-deductible. But there is a significant drawback. You are trading unsecured debt for secured debt. Credit card companies can do little more than report your payment history to credit reporting agencies, resulting in a negative credit history. However, the mortgage company can -- and will -- take your home.

UNDERSTANDING WHY YOU COULDN'T SWIM IN THE FIRST PLACE

No debt consolidation strategy will succeed until you deal with the causes of your debt. "The first stage of problem debt is denial. If the debt stems from fundamental underlying issues, like living beyond your means, then debt consolidation can be the worst choice," cautions Steve Rhode, president and co-founder of Myvesta.org. "I have seen many people consolidate their debt only to wind up in trouble again. You can wind up in deeper trouble if the underlying issues are not addressed."

If you find yourself in this situation, consider seeking counseling from a certified therapist or psychologist who specializes in behavioral finance -- the application of psychology principles to managing and understanding of money. Kathleen Gurney financial psychologist and author of Your Money Personality: What It Is and How You Can Profit from It (Doubleday; $37.98), developed the Moneymax Financial Personality Profile. The questionnaire determines attitudes on 13 financial traits that influence money behavior and investment decisions. It helps individuals change self-sabotaging money styles into styles that are more productive and enriching. To discover your money personality with this profile, go to www.kathleengurney.com.

While these forms of debt consolidation may work for some, they may not work for you. In that case, there are viable options you can exercise to help protect your credit rating. If your credit is good, call your credit card companies and ask that they lower your interest rates, set all of your due dates to the same day, and waive any over-the-limit or past-due fees. Then aggressively pay off your debt. If you are behind in payments to your creditors, consider negotiating a workout arrangement, which is an installment agreement with one or more creditors for settling the debt for less than you owe.