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Debt consolidation loans can deepen financial problems

Be careful when considering a debt consolidation loanThe average American family with at least one credit card carried a balance of $7,942 in 2000.

It's no wonder debt consolidation loans, with their pitch of lower monthly payments, sound so attractive.

For individuals in a bind because of a job loss, an extended illness, a divorce or other major life experience, a debt consolidation loan can be a way to dig out of a hole they never thought they'd fall into.

But experts say far too many people use them simply to delay the inevitable.

A personal finance illusion
"It makes sense if you use it to get out of debt and you have a plan, but not to breathe a deep sigh of relief and get back in the same situation," says Durant Abernethy, president and CEO of the National Foundation for Credit Counseling. "The fundamental problem is you're living beyond your means and you're just postponing the day you go bankrupt."

In fact, Abernethy says, up to 25 percent of people filing for bankruptcy appear current on their bills because they're taking out new credit cards or cash advances to pay their bills.

Greg Pahl, author of The Unofficial Guide to Beating Debt, (2000, IDG Books Worldwide, Inc.), says that debt consolidation loans need to be approached with extreme caution.

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"Borrowing money to get yourself out of debt can be a disastrous mistake for some people," he says. "They need to understand what they're getting into. If they do it wrong, they can end up being in a worse situation than when they started."

Betting the house
The most dangerous debt consolidation loan is a home equity loan that uses a borrower's house as collateral for the loan. While it may sound simple, it's an extraordinary risk because of the potential for foreclosure.

"For most people, their home is their largest asset," Pahl says. "Putting that at risk really doesn't make much sense. Millions of Americans do that every year and that really scares me."

Another expert says consumers should beware of any loan that advertises debt consolidation as a simple solution to a serious situation.

"Anytime an ad or a lender says, 'We're going to solve your problems' without saying, 'What are you going to do to solve your problems?' that's a warning sign," says Virginia Morris, co-author of The Wall Street Journal Guide to Understanding Money & Investing (2000, Light Bulb Press). "Look out for words like 'easy,' 'painless' and 'can't be turned down.' Those are danger signs."

Watch out for fees, closing costs
Finance companies that deal primarily in debt consolidation loans are among the worst options for consumers in need of a loan, Morris says. The fees and closing costs are often "enormously high," she says. Pay attention to the difference between the interest rate offered and the annual percentage rate.

"Closing costs on a regular mortgage might increase APR by half a percent," she says. "If you're looking at an increase from simple to APR that's more than that, that's a real warning sign."

Also, consumers should stay away from finance companies that discourage borrowers from visiting a credit counseling service.

"One of the things these commercial Web sites say is that you don't want to go to a credit counseling service because it will show up on your credit report," Morris says. "That's a false alarm."

It's also a moot point. By the time most people go shopping for a debt consolidation loan, they already have plenty of problems with their credit reports.

The reality, Abernethy says, is that people don't get into debt overnight, and a debt consolidation loan won't help a bit if they don't change the way they spend money.

"Be very wary of a consolidation loan," he says. " There's hundreds of nonprofit credit counseling offices across the country that will be happy to help you for free or a very low fee to develop a comprehensive budget and repayment plan, work with the creditors, and help you get back on your feet."

Pat Curry is a freelance writer based in Georgia

-- Updated: May 18, 2001


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See Also
Eight ways to get help with your debts
How one couple escaped from the hell of debt (5/12/00)
The right call can lift the credit card blues (1/24/00)
Lenders cut support for debt counseling programs (9/13/99)


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