Military Debt Consolidation

Debt consolidation tips for Service Members & their families

The Servicemembers Civil Relief Act (formerly called the Soldiers’ and Sailors’ Civil Relief Act) is an important piece of legislation that provides special considerations for Service Members currently on active duty. The provisions include reductions on interest for credit card debt, as well as potential discounts on related programs, including a debt management program that you enroll in through a credit counseling agency.

As long as you can prove that you’re eligible under the law, you may be able to qualify for a debt management program with reduced fees. Depending on where you go, some credit counseling agencies will waive some or all of the fees associated with your program. So make sure you shop around and always make sure you mention that you are an active-duty Service Member – or a service family.

Bear in mind that fees on these programs are actually low to begin with, since they’re based on what the consumer can afford in their budget. However, it’s worth exploring to save yourself a few bucks when you’re working to get ahead. As for us, Consolidated Credit waives all program setup fees for military service personnel and their families.

Tip No. 1: Consolidate before you deploy

Trying to make arrangements after you’ve already deployed will only make it more challenging at a time when you don’t need the distractions. So you should consolidate your debt prior to deployment as you get your finances in order so they can be managed easily while you focus on the mission.

Keep in mind that the right debt consolidation option typically reduces your monthly payment amount, as well as simplifying your payment schedule to just one bill for all debts you consolidated. So consolidating makes it easier to manage payments AND makes your debts more affordable so you’re less likely to fall behind.

Tip No. 2: Consider a debt management program

There are several different ways to consolidate, but the best for Service Members on active duty or a reservist anticipating Extended Active Duty (EAD) are either to use a personal debt consolidation loan or a debt management program.

The consolidation loan is a good option for consolidating a limited amount of debt from multiple sources if you have a good credit score. If you have too much debt or you don’t have good credit, a loan can be problematic. In this case, consider a debt management program (DMP) through a credit counseling agency. It’s an assisted form of consolidation that can reduce your total monthly payments by 30 to 50 percent regardless of your credit score.

Tip No. 2:  Make sure your interest rates are reduced

The Servicemembers Civil Relief Act (SCRA) states that interest rates for deployed active duty soldiers are capped at 6 percent. However, this 6 percent cap is only automatic on federal student loans. For all other debts, including credit cards and debt consolidation loans, you must request that your rates are reduced and may need to provide an SCRA certificate as proof of your deployment.

Also keep in mind that 6 percent is the maximum. You should talk to each creditor or lender to see if they are willing to reduce your rates further or eliminate them entirely. Doing this for consolidated debt is easier, since you only have to make one call to cover all your debt rather than individual calls for each debt owed.

Tip No. 3: Talk to your credit counselor if you’re on a DMP

The interest rate cap mentioned above would also apply to the debts included in a debt management program. In most cases, your interest rates should already be reduced or eliminated once you enroll – interest rates are typically reduced to 10 percent or less even for civilians who use this to consolidate. Credit counselors negotiate with your creditors at the time of your enrollment.

Still, call your credit counselor if you’re enrolled in the program to make sure your rates are all reduced to below 6 percent. If not, the credit counselor should be able to get you an additional deduction thanks to the SCRA. In addition, program fees may also be waived for a deployed Service Member, so call to see what the agency can arrange for your program before you deploy.

Tip No. 4: Set payments in your 6 discretionary allotments

Any active duty Service Member as well as reservists on Extended Active Duty (EAD) can set up pay allotments, where a set amount of money is automatically taken from your pay and distributed to a designated person or business. You are allowed up to 6 discretionary pay allotments at a time.

Officers and enlisted members can authorize payment for personal loans, which would include a debt consolidation loan. By consolidating your debt, you make it easier to manage during deployment because you can set one discretionary allotment to cover the loan payments on the consolidated debt.

Tip No. 5: Remember to set up special Power of Attorney

If you have someone you’re designating as your financial manager while you’re away, such as a spouse or parent, you need to establish Power of Attorney. However, it’s important to note that if you want that person to have the ability to make changes to allotments this requires special Power of Attorney to be set up.

Make sure if you’re setting up allotments that you obtain the appropriate Power of Attorney that will allow the person you designate to adjust pay allotments as needed.

Tip No. 6: Put credit cards on freeze while you’re deployed

Generating credit card debt while you’re deployed only increases the obligations you have to worry about. So once you simplify your debts through consolidation before you deploy, don’t then complicate things by taking on new high interest rate credit card debt.

This includes credit card debt from your spouse or designated Power of Attorney or any authorized user on your credit cards. Whoever is managing your finances should use available cash and avoid taking on debt you’ll have to worry about later.

Tip No. 7: Take advantage of an SDP

If you’re deployed to a combat zone where you receive Hostile Fire Pay / Imminent Danger Pay (HFP/IDP) you’re eligible for the Savings Deposit Program (SDP). This is a special savings account that earns ten percent interest, which makes it a very strong investment tool.

Since an SDP grows at 10 percent and the interest rates on your debts are capped at 6 percent, it’s in your best interest to make contributions to an SDP rather than using your pay to try and pay off more debt that the required payments. Set up an SDP and make contributions to use your money most effectively. Then you can use it for strategic debt elimination once you return from deployment.

Tip No. 8: Consider a lump-sum debt payment with your SDP

Once your return from active duty, your income is likely to decrease so the money in your SDP may be needed to help you transition back to a normal non-deployed budget. You should receive your money in a single lump sum. Then you will need to divvy it up and use it wisely. However, if you have extra money from the account you may consider using it to make an extra payment on your consolidated debt.

Remember that interest rates will no longer be capped at 6 percent and may return to their original higher values. This means it’s in your best interest to pay off the debt before those higher charges can be applied. Using part of your SDP can help you achieve stability quickly without worrying about a large overhang of debt.

Debt Consolidation Loans for Veterans

Veterans have a few options when it comes to consolidating debt as well. The first option applies only to Veterans who own their home with a VA home loan. If you went through the VA to get a mortgage you are eligible to use a Military Debt Consolidation Loan. This is a loan borrower against the equity built up in your home, so it’s like a home equity loan specifically meant for Veterans.

As a Veteran, you face some unique financial challenges in establishing a stable outlook once you transition to civilian life. Making that transition can be tough, but there are also specialized tools available to Veterans who are working to overcome those challenges to achieve stability.

The information below is designed to help you understand what a Military Debt Consolidation Loan (MDCL) is, how it can help you, and the risks you need to know before you decide to use it. If you have a question or need expert advice on your best option for debt relief, we can help. Call Consolidated Credit today at (844) 276-1544 to request a free debt and budget analysis from a certified credit counselor.

#1: A Military Debt Consolidation Loan (MDCL) is a home equity loan

There are two types of debt consolidation loans. An unsecured debt consolidation loan requires no collateral, so the loan is extended to you in good faith based on your credit score and financial situation.

By contrast, a secured debt consolidation loan requires some collateral to secure the loan in case you default. In most cases, the collateral is your home, so you take out what’s known as a home equity loan. You’re essentially borrowing against the value of your home.

#2: You must have a VA home loan in order to qualify

Not all Veterans can use a Military Debt Consolidation Loan. Veterans are only eligible if they already have a VA home loan. Basically, the MDCL – also known as a VA consolidation loan – is like a specialized second mortgage for Veterans.

This means if you aren’t a homeowner or you own a home but didn’t go through the VA to get your loan, you won’t be able to use an MDCL. There are other options available for debt relief, however, so you’re not completely stuck (more on other options in #10).

#3: An MDCL is a “cash-out” loan on your home

As mentioned above, an MDCL means you’re borrowing against the equity in your home. Equity is the value of your home minus the remaining balance on the mortgage. So if you have $80,000 left to pay off on your VA home loan and your home’s property value is $120,000, then an MDCL would net you $40,000 that can be used to pay off your credit cards and other outstanding debts.

It’s important to note that this effectively means you cash out the equity built up in your home, so now you have $120,000 in mortgage debt instead of $80,000 in mortgage debt with $40,000 of equity (which counts as an asset).

#4: You will have to pay closing costs

Almost any time you modify, refinance or take out a second mortgage, you will be required to pay closing costs again to secure the new loan. Closing costs generally equal about 1-5% of the purchase price of your home – in this case with an MDCL that would be 1-5% of the new amount on the loan.

You can use part of the money you get for the MDCL, so if the payout is $40,000 you would get that money minus $1,200 to $6,000 in closing costs, depending on the lender. Make sure you know exactly what your closing costs will be, to see how much it will reduce the final payout.

#5: A MDCL is not a loan issued by the VA

This is a common misconception with all VA loans. The VA is not the lender or the loan servicer. Private financial institutions are still the issuers of VA loans, just as they are with regular civilian consumer loans. The VA simply guarantees as much as 25% of the loan, which allows Veterans to get these loans at lower rates and better terms. There are also caps on what banks can charge for VA loans.

However, you still apply for any VA loan, including a MDCL, through your preferred lender.

#6: An MDCL increases your financial risk

When a Service Member is on active duty they are offered some key financial protections under the Servicemembers Civil Relief Act (SCRA). This includes protection against foreclosure if you fall behind on your mortgage payments when you’re deployed.

Unfortunately, Veterans are not offered the same protections and, in fact, there are no such protections offered by a VA home loan or an MDCL. If you fail to pay and the loan goes into default, the lender can start a foreclosure action against you. And if you can’t find the right option to save your home, you can lose it in foreclosure.

#7: The MDCL will increase your monthly payments

The monthly payments on the new MDCL loan will be higher than the monthly payments on your current VA mortgage because you’re financing a larger amount. At 4.5% APR, the monthly payments on the remaining $80,000 balance on your home loan should be around $405. The payments on the MDCL at $120,000 at the same 4.5% APR would be around $608.

The good news is that you should have fewer obligations to cover besides the loan. If you’re paying $500 per month on your credit card bills and you pay off those debts in-full with the money you get from the Military Debt Consolidation Loan, then a $200 increase your monthly mortgage payments will still leave you with a net budget cash flow increase of $300.

#8: Market conditions matter

As with any home loan, current conditions in the real estate market will impact the rate you receive on the new loan. Although going through the VA can help you qualify for a lower interest rate on the MDCL, rates are still based on current market conditions.

With that in mind, timing can be a key factor in getting the rate interest rate on your loan. If you apply for a Military Debt Consolidation Loan when rates are low, then you’ll get a lower rate and pay less interest charges over the life of the mortgage. If you apply when rates are high, then your interest rate will be higher and you’ll pay more in total.

#9: If you don’t have equity, an MDCL won’t work

The VA provides definite benefits when you apply for financing, but it can’t help you if the money is not there. Like any home equity loan, an MDCL only allows you to borrow against the equity available in your home. If you have no equity, there’s nothing to borrow against.

So if your home’s value is not significantly higher than the remaining balance on your VA home loan, then an MDCL will not be a viable option. It’s also out of the question if you’re upside on your mortgage – where the property value in your home drops below the remaining balance on your mortgage.

You need significant equity in your home for an MDCL to be the right option for consolidation. Even if you have some equity, you need to make sure it’s enough to work for what you need. For instance, if you have $80,000 left on your mortgage and the home is worth $100,000 that would net you $20,000 for consolidation. However, if you have $35,000 in credit card debt to pay off, that amount is not enough to serve the purpose you need it to serve.

#10: An MDCL is not your only option

If you’re worried about borrowing against the value of your home or you don’t have the equity available to serve the purpose you need for debt elimination, don’t fret. There are other options you can use which can help you solve the challenges you face with credit card debt.

A debt management program through a certified credit counseling agency allows you to consolidate without borrowing against your home’s equity. Interest rates are negotiated with creditors individually, and typically range from 0-10% once negotiated. Credit card debt becomes easier to manage once the interest rates are reduced, so you can get out of debt faster even though you may be paying less each month.

Most borrowers who complete the program successfully are debt-free within 5 years even though their total monthly credit card payments are reduced by 30 to 50 percent. Credit counseling agencies may also have specialized programs for Service Members and Veterans that offer lower fees.