Interest rates haven’t been this low for decades, tempting some consumers to take on additional debt to ease existing credit woes. The goal is to consolidate various higher-interest balances into one, easier-to-handle and less-costly package.
But be careful of what looks to be a quick fix.
“You’re getting symptomatic relief, not a credit cure,” says Chris Viale, general manager of Cambridge Credit Corp., a nonprofit credit counseling agency based in Agawam, Mass.
This fighting-fire-with-fire approach can take several forms. There are debt-consolidation loans, balance transfers to a zero-percent credit card and home equity loans or lines of credit.
But, says Viale, 70 percent of Americans who take out a home equity loan or other type of loan to pay off credit cards end up with the same (if not higher) debt load within two years.
Viale’s statistics underscore a major problem with debt consolidation: It feeds upon the tendencies that got you in trouble in the first place. By taking on yet another creditor, you’re adding the proverbial fuel to the fire. In this case, it’s your money that’s burning.
Plus, if you’ve taken on so much debt that you’re looking for more as a solution, chances are you won’t qualify for the very low interest rates you see advertised. Those generally go to people with stellar credit ratings.
However, if you’re at the end of your credit rope or swear that this time you’ll be more disciplined, debt consolidation may be something to consider despite its risks. Here are some popular forms of debt consolidation, how they work and a look at their pros and cons.
Home equity loan or line of credit
Home equity lines or loans often are touted as a quick and easy way to get out of debt. By leveraging your residence’s value, the pitch goes, you can get money to pay off other bills and a tax break, too.
But borrowing against your house can backfire. The biggest risk: You could lose your home if you default on the loan.
“Some hardship occurs and now they have double the debt and if it’s secured by their home, they could lose it,” says Diane Giarratano, director of education at Garden State Consumer Credit Counseling in Freehold, N.J.
And while equity loan interest generally is tax deductible, it could be limited in some situations. Even when it does provide a tax break, Cambridge’s Viale says “that doesn’t mean it makes fiscal sense.”
Giarratano agrees. “Banks will tell you how much you can borrow,” she says. “That doesn’t mean you should borrow the total amount, but that’s what people do.”
Still, a home equity line of credit or loan to pay off creditors can work for some debt-burdened homeowners. Just be sure to do your homework to guarantee that the home equity dollars and cents make sense. This Bankrate calculator can help your determine whether borrowing against your home’s equity is a wise move.
Zero-percent credit card
What about people who don’t own a house? In these cases, many turn to zero-percent credit cards to reduce debt. Again, prudence and discipline are required.
Companies offer these rates as teasers — enticements for you to switch credit card vendors. Much of the time, card companies target consumers with better credit, so that may leave someone struggling with debt without this option.
Even if you do qualify for a zero-percent or similar single-digit rate, it won’t last forever. Make sure you know when it will end and what the rate is expected to jump to when it does.
The low rate also lasts only if you pay on time. One late payment and the credit card company will jack up the rate. Also look for hidden fees and charges that can increase the actual cost of credit….. read more »