Since the onslaught of the Great Recession, many Americans find themselves deeply in debt with no hope of paying loans back without changing how their payments work. Many Americans are finding that bankruptcy is a viable option, especially since the stigma against bankruptcy is fading as the Recession continues. Some Americans, however, are choosing to utilize the services of debt consolidation firms first, which can be a risky financial step.
Debt consolidation occurs when a debtor, with the help of a home equity line of credit, Chapter 13 bankruptcy or a debt consolidation firm, combines his or her debt together into one payment with one interest rate. Doing so makes the payments easier to manage and can make the monthly payment smaller by extending them over a longer span of time. Under Chapter 13 bankruptcy and at many debt consolidation firms, the debtor makes payments to the courts or the firm, which then makes payments to the debtor’s creditors.
While debt consolidation is a great option under Chapter 13 bankruptcy, since the payments are regulated by the law and overseen by the courts, using a debt consolidation firm to consolidate debt does not provide this critical oversight and can be a risky undertaking.
Many debt consolidation firms have cropped up since the Recession hit in 2008. Many are for-profit companies, though non-profit firms do exist. These companies offer loans to customers which will cover the cost of their debt repayment and then take over the responsibility of repaying their customer’s loans. Instead of paying each creditor separately, customers make one payment to the debt consolidation firm. The interest on the new loan is usually lower than on the previous debts, but since debt consolidation firms make their money on interest, companies often stretch payments out over a longer than necessary period of time. This makes payments easier for debtors every month, but increases the amount of interest paid, and therefore the total for the debt consolidation loan is often higher than the original loans.
In addition to stretching out payments to make more on interest, debt consolidation firms also charge customers monthly maintenance fees, often close to 20 percent of the customer’s monthly payment. Since the firm is getting paid monthly by the customer, there is less incentive for them to make timely payments on the customer’s behalf. This can hurt the customer’s credit score further and make them susceptible to penalties and late fees issued by their creditors.
Finally, unlike the Chapter 13 bankruptcy process, where creditors are required by law to work with the debtor, creditors can refuse to work with a debt consolidation firm, leaving the customer with an extra debt payment in addition to the payment to the firm.
Debt consolidation firms seem like a good deal on the surface, but there are better, more legally protected ways to consolidate debt; ways that leave the debtor in a better financial position at the end of consolidation, not a worse one. If you or a loved one are trying to get out from under a pile of debt, please seek the advice of an experienced bankruptcy attorney.
