American Consumer Debt industry is a rapidly growing part of our economy, for better or for worse. As the country’s main provider of the average household’s liquidity, credit providers help to facilitate our lives by bridging the gaps between salary and expense, while also providing us with a vehicle to enjoy the occasional luxury on the side. However, many of us can agree that it is very easy for a debt holder to become overwhelmed by their obligations. In fact, the US Census Bureau has found that a full sixth of the American population is bravely facing down bankruptcy, as they carry monthly credit card balances of over $10,000.
These individuals are joined by the full third of the credit-card carrying population that are unable to pay off their full balance at the end of every month. Combined with the burden of living expenses, family expenses, mortgage debt, and even the massive obligations associated with taking out pay-day loans to manage all of these expenses, it is no wonder how credit balances have increasing by an average of 30.4%, even though overall debt levels in the US have decreased. What’s worse, much of the overall decrease in debt can be attributed to default, as opposed to a sudden increase in the ability of consumers to pay off their loans.
What does this all mean? It means that, as average US citizens who carry on a monthly battle against a rising debt-load, it is important that we begin to look into the causes of what is contributing to this burden, and more importantly, how we can begin fighting it back. Specifically, I’m going to take this opportunity to share with you what I’ve learned over the years about debt consolidation, and how you can build it into your financial plan to wrestle into submission.
Where Is All This Debt Coming From
The first thing to consider when looking at rampant debt is its sources. In the US, as of 2011, the Federal Reserve has cited that 98% of our debt comes from credit cards.
In addition, credit card issuances have increased by 13.6%, meaning that we are aggressively pursuing even more credit card debt, even though it causes our net obligation to increase dramatically. Even though 15% of all credit card applications are rejected due to a poor credit application, the largest credit card companies are still issuing hundreds of billions of dollars in credit card debt to meet the American demand. What’s worse is that a full 36% of the applicants for these cards (as of 2009) don’t even know the interest rate on the card they use most often.
This offers some insights as to why it is we’re seeing such rapid growth in debt obligations, because the average interest rate on a credit card today is 14.1%. Not that this rate matters though, because 93% of cards allow the issuer to raise their interest rates at any time, and the holder is required to either accept the new terms, or immediately pay back all of their balance at once and terminate the contract. Lastly, this average rate also takes into consideration that fact that many credit cards will be issued with a low ‘teaser rate’, that will is traditionally replaced with a much higher one as soon as the card-holder makes a single late payment. This means that the 14.67% average is skewed, as it is likely composed of a low 9% teaser rate, which is then replaced with anything as high as a 29% rate within the year.
Without a doubt, the problem is credit card obligation. But now that we know the problem, surely we can better assess our options.
Consumer Debt Options
When dealing with consumer debt obligations, the average American has a range of options available to them. Ranging from buckling down and paying off their debts, to declaring insolvency and filing for bankruptcy. In this section, I’m going to outline all the options available to you, and describe how they might apply to you
Bankruptcy is the least favorable outcome for a person in debt. It involves the drawn-out legal process of submitting yourself to the state for liquidation, in the hopes of getting a clean start. However, the process is expensive, humiliating, and extremely drawn out. By declaring bankruptcy, you submit your assets to a trustee of the state to liquidate on your behalf, while you continue to struggle on for the next few years dedicating what the law defines as “all disposable income” towards the reasonable repayment of your debt.
While you won’t necessarily be required to pay off the full amount, it will still be a large amount. What’s worse, all of your assets (your house, your car, your stereo) will become the legal property of the trustee. You’ll suddenly find yourself living in someone else’s house, driving to work in someone else’s car, and buying groceries only because someone else let you.
Now that you understand Bankruptcy, forget about it. The purpose of this article is to teach you how to avoid it through other options. If you’re willing to fight for your financial independence, you’ll never need to worry about bankruptcy.
- Financial Planning
The aid of a professional wealth manager is your most valuable resource for planning out your personal debt. Their wealth of experience and valuable industry contacts will be there to support you throughout your journey towards financial independence. Best of all, their services may at times be tax deductible, depending on where you live.
of a financial planner, you are able to make a long term plan that will help you structure your income and expenses towards paying off your debt. However, there are some times where not even the most frugal of spending plans can save you from your mounting interest charges. Don’t worry, this is not the end of the world. Credit companies usually have staff devoted to reassessing their clients’ ability to pay, and are more than willing to renegotiate payment terms and even interest rates to ensure that you are able to make your payments.
Think about it as a business decision, they would much rather see you make your payments, than default on them. You, on the other hand, would also like to make your payments, rather than default on them. Both parties have a mutual interest to see the balance fulfilled, creating an opportunity for negotiation. Give your company a call, and see what they have to say.
One of the most practical options you have available to you when planning out your consumer debt is consolidation. Consolidation operates under the assumption that you are currently overpaying for your debt at a variety of rates, because you have purchased it from many different providers. For example, if you have a mortgage costing 5%, three credit cards charging 10%, 14%, and 18%, and pay another 15% on payday loans on a total debt of about $150,000, each company that you owe money to is only receiving a fraction of the total interest associated with your total debt load, while you are therefore paying a higher interest rate than what the market has decided is acceptable (in this situation, the market says your credit card debt alone should be worth only 10%, but because you have received different rates from different providers, you have increased your average rate).
If we look at this situation from the credit card company’s perspective, would we make more profit as a business if we increased your limit on the 10% card, and therefore stole all of your business that was originally being given to the competing companies charging you 14% and 18%? Better yet, from the bank’s perspective, if you have additional equity available in your home (say the value of your house has risen, or you have been diligently making payments), would it not make sense to extend your balance at 5%, so as to consolidate all of your credit card debt under the 5% mortgage rate?
Thus is the logic of debt consolidation. A single company agrees to merge all of your debt under its own lower interest rate, in exchange for either an addition of collateral, or a more structured balance requirement. In return, you receive a lower interest rate, a more favorable payment term, and the ability to better plan your debt, as it is all consolidated into a single statement every month.
Benefits and Drawbacks of Debt Consolidation
When compared with Bankruptcy, or even continuing to struggle with multiple rates from more than one company, consolidation provides a very appeal strategy for addressing consumer debt. While the possibility of obtaining a lower overall interest rate on your total personal debt is extremely appealing, it’s important to also recognize how much easier debt is to manage when it’s all on a single statement. By having the same payment date for all of your loans, it might be possible to reduce, if not eliminate, the need for bridging capital from pay-day loan companies, because you no longer need to make payments at awkward dates.
Additionally, a consolidated debt is more secure than a scattered one, because of the way that you are better able to keep track of your record. With only a single transaction record to watch, identity theft, fraud, and erroneous billing (a surprisingly frequent occurrence) is much easier to keep track of, therefore putting you in greater control of your finances. Essentially, it is easier to steal a credit-card number than it is a line of credit.
However, when considering a consolidated line of credit, it is also important to keep in mind that there are a number of serious risks involved as well. Usually you will need to provide some sort of additional security to the consolidating company, as a means of providing them with additional security for their lower rate. This could include the provision of additional collateral assets (ie. Car or home equity), or extending the payment plan of the loan. While an extended payment plan provides a benefit to you because it requires less collateral, and fits the payments within your budget, you will wind up paying a larger total amount of interest overall.
Lastly, it is important to remember that you are still in debt under consolidated plan, even though it has become more manageable. While some companies will require that you refrain from drawing upon excess credit upon consolidating, it is important that you remember your goals of cutting back on debt, and seek try to live as much as possible within your existing means. While this may seem difficult at first, a financial planner can help you to find out exactly where you can save the most money, and therefore maintain as much of your lifestyle as possible.
With these impacts in mind, it is also important to keep in mind the integrity of your credit score. While the consolidation of your debt will not necessarily have a major impact on your overall score, your actions will likely be noted in your account. It will be noted that you are in the process of pursing credit counseling, and that you have taken on a different kind of debt. It will also be noted that you have paid off a deal of outstanding debt to the effect of zero. In reality, the only real risk to your credit score lies in your ability to make payments. If you are able to take advantage of your newly consolidated credit to better make your debt payments, you will see a long-term improvement in your credit score.
However, your credit score will decrease if it becomes apparent that you have entirely closed down your accounts with your previous lines (ie. You close down your credit card accounts). Counter-intuitively, credit scores see your capacity to drawn upon credit as being a positive factor. What this means is that you must find a way to consolidate your debt, while still maintaining access to your existing credit lines, even though you don’t intend on using them anymore. The result will be that you have access to a better interest rate and payment term, and will have access to better credit in the future.
Debt Consolidation Scams
As a final note of caution, I want to take a moment to warn you about some addition risks that are associated with debt consolidation. Specifically, there are a number of less-than-reputable organizations in the debt-industry that seek to consolidate a client’s debt for their own corporate gain. For example, a company that offers to consolidate debt at a lower rate, provided that the client invests the money in a set of securities through the loaning company’s branch is not looking out for the client’s interests, but instead for their commission checks. Stay away from these guys. Additionally, beware of companies that offer you a ‘silent second’ mortgage, as opposed to a consolidation.
These second mortgages represent a second claim on your home, and come with all sorts of dodgy legal elements that are not worth your time to risk. Where possible, try to avoid double-dipping on your collateral. Lastly, beware of tiered interest rates meant to lure you into debt. Many loan companies try to attract customers with extremely low beginning rates for a short period of time, and then proceed to trap their customers into very high rates when they least expect them. Make sure you read all the fine print, and are simply applying for a single fixed-rate, so that you can best plan your finances around the payments.