Debt consolidation loans can deepen financial
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
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.
"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
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 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
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
"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