As a legal advisor, I've come across many people who've gone through some extremely nightmarish situations due to debt. They have been lied to about the financial services they selected, made poor financial decisions or encountered bad debt consolidation companies with programs they were assured would help.
Debt Consolidation Companies Can Be Unreliable
I ran into an example of a terrible situation where a couple with two young children had fallen on hard times. While they had always managed their debt responsibly, they had both become unemployed and were becoming overwhelmed with debt very quickly. When a medical emergency arose, they sought counseling from a debt consolidation company in order to combine their bills into one manageable monthly payment.
Yet, less than a few months later creditors began calling, threatening lawsuits for having fallen behind on their payments. The debt consolidation company they had contracted with had not allocated their money toward any of their bills. Even though they had plenty of equity in their home, they couldn’t access it because their credit scores had plummeted to the point where they could not qualify for an equity line, nor could they refinance.
If they had made arrangements themselves with their creditors, they may have been able to negotiate a repayment plan. Also, if they had refinanced their home at a reasonable rate before their credit scores fell, they may have been able to access cash to pay their bills and create a cash buffer in savings to weather through hard times. Eventually, they chose to file a Chapter 13 bankruptcy to get their debt under control.
What Do Debt Consolidation Companies Do?
Debt consolidation companies generally offer one of the following:
- Debt consolidation loans
- Debt consolidation services
Financial lenders and institutions generally offer debt consolidation loans for people drowning in debt. As with any financial obligation, they require a great amount of responsibility and should be considered as a last resort. A debt consolidation loan does nothing to help you change the behavior that created the debt. These loans are rarely accompanied by needed credit counseling and because it is considered a new loan, they have the potential of crippling your credit. Defaulting on a debt consolidation loan will intensify an already struggling financial situation.
Debt consolidation services, on the other hand, are intended to get consumers out of debt, and sometimes offer counseling to encourage better long-term spending and saving habits. A debt consolidation counselor is supposed to negotiate creditor terms to result in lower interest rates and lower monthly payments, by combining debt to calculate one monthly payment. Your one monthly payment is then divided amongst your creditors. Unlike a loan, your payment is distributed to your debtors on your behalf. The problem is, there is no guarantee that your payment will be distributed according to the agreed terms (as in the example above), and the debt consolidation companies usually require an up-front fee as well as monthly fees for the service.
The fine print in many of these debt consolidation companies contracts can come back to bite you quickly. Being naïve about how to deal with your financial goals can lead to a debt crisis, especially when you don’t understand how debt consolidation programs, loans and services work.
What Are The Alternatives?
You should research companies online, ask a lot of questions and don’t allow yourself to be pressured into programs you don’t understand. In addition, compare these programs and services to other similar solution alternatives to debt consolidation, such as filing a Chapter 13 bankruptcy, before you commit to any financial debt-relief program. With a limited plan length of 3-5 years, you can prioritize your debt in a Chapter 13 and pay what you can afford.
With a Chapter 13 bankruptcy, at the end of the term, unpaid, unsecured debt is wiped out, tax free. During this time, creditors and bill collectors will stop harassing you, which is a huge stress relief for many families. If you have no assets to lose, and limited income that only covers your family’s basic needs, you may qualify for a Chapter 7 bankruptcy. Talk to a financial advisor or legal professional to find out which solution would be best for your unique situation. For many people drowning in debt, these alternatives can be the difference between sinking and swimming.
For more information about the financial risks and dangers involved with debt consolidation loans and services, and why filing a Chapter 13 bankruptcy might be the best solution for your financial struggles, download our free eBook, The Truth About Debt Consolidation.