How Debt Consolidation Can Go Wrong
Daniel Montville knew that a debt consolidation loan wouldn’t solve his financial problems, but the hospice nurse hoped it would give him some breathing space. He had already filed for bankruptcy once, in 2005, and was determined not to do it again.
Montville took out the loan in 2015, but within a year he was behind on payments and the payday loans he got to help his daughter, a single mother with four children. Payday lenders virtually wiped out his checking account every time a paycheck came in, leaving little money for necessities. Then her daughter lost her job, and the $ 5,000 tax refund she had promised her was used instead to support her children.
“That’s when I realized and realized this was a no-win situation,” says Montville, 49, of Parma, Ohio. Montville is now repaying its creditors under a five-year Chapter 13 bankruptcy repayment plan.
Debt consolidation may seem like the answer to the prayer of a struggling borrower, but often it doesn’t answer the overspending that caused the debt in the first place. In a short time, borrowers often find themselves buried deeper in bills.
“It’s a quick fix,” says Danielle Garcia, credit advisor at American Financial Solutions in Bremerton, Washington. “They are not solving the root of the problem.”
Out of the frying pan
The five-year $ 17,000 loan Montville got from his credit union, for example, paid off 10 high-rate credit card bills, lowered the interest rate on the debt by double digits to about 8. % and offered a fixed monthly payment of $ 375, less than what he was paying combined on the cards.
What the loan did not do, however, was change Montville’s spending habits. Paying off the credit cards just gave it more room to charge.
Part of the debt came from unforeseen expenses, such as auto repairs. But Montville estimates that 60% came from “senseless spending.”
“I wanted a TV. I needed clothes. I want to go to the movies, ”says Montville. When he bought a new computer, he only noticed the low monthly payment of $ 35, not the 25% interest rate he was charged. When his daughter got into financial trouble, he turned to payday loans because his cards were depleted.
Now that he can no longer borrow – his credit card accounts are closed and he would need bankruptcy court clearance to replace his car – Montville is finally considering what to actually buy versus what to buy. ‘he wants to buy. He wonders if he can do without a purchase or postpone it. If he really wants something, he saves for it.
“My feeling now is to only pay cash,” Montville says. “Once I pay cash, no one can take it from me. “
Consolidation a strategy, not a cure
Montville’s attorney, Blake Brewer, says many of his clients have no idea how their expenses compare to their income. They assume that their next tax refund or their next overtime will help them catch up, not realizing that they are constantly spending more than they are earning.
“These people are just shocked when I sit down with them and pull out a calculator,” Brewer says.
Some of his clients have consolidated their debt using a 401 (k) loan or home equity line of credit. They pride themselves on saving money because they lowered their interest rates, but they don’t realize they’re spending assets – retirement accounts and home equity – that would typically be protected. against creditors in bankruptcy court.
People who are looking for debt consolidation may also find themselves with debt settlement companies, which promise to persuade creditors to accept less than what is owed to them. Debt settlement usually causes a major impact on credit scores, but success is not guaranteed and some businesses simply disappear with the thousands of dollars they charge.
Debt Consolidation Loans – through a reputable credit union or online lender – it doesn’t have to be a disaster if borrowers:
Save for emergencies so they don’t have to borrow to cover unforeseen expenses
More importantly, their debt must be manageable and payable within three to five years of the typical debt consolidation loan. If it took more than five years to repay the debt on their own, borrowers should consult a credit counseling or bankruptcy lawyer.
“By the time most people go for help, they’re already too deep,” says Garcia, the credit counselor.
Liz Weston is a Certified Financial Planner and Columnist at NerdWallet, a personal finance website, and author of “Your Credit Score“. E-mail: [email protected] Twitter: @lizweston.
This article was written by NerdWallet and was originally published by The Associated Press.