Foolish debt consolidation options

Financial institutions are really pushing remortgaging as a debt consolidation option. The financial benefit to the institution is clear, they now own a bigger chunk of your debts.  This means that they will make more profit from your debt.  They do this in two ways. First, they now own more of your debts.  Second, they convinced you to turn your personal loans arranged on a 2 – 5 year period into 10 – 20 year loans.

At first the lower APR makes them look attractive. However, if you look at the total cost of borrowing the money over a longer period, then you’ll realize that for the first half of the mortgage you are doing nothing but paying the interest.  That means, for as much as ten years, you are not paying off your mortgage.  All you are doing is helping the banks profit.

Many people who opt for this type of debt consolidation wonder, at a later date, whether they are prone to seizures.  Something made their brain stop working.

It is one thing to take equity from your home to repay debts that threaten to drive you into insolvency.  But, to remortgage for 10 years to pay for a car that you won’t have in 5 years, or worse, to pay off your store cards, boarders on lunacy.

The APR of the second mortgage may only be 8%, instead of the 30% the store cards are charging.  The monthly payments may also be something that fits your monthly income without stretching it to the limit.  If that was all that you needed to restructure your finances then it may be a good move.

Unfortunately, most people obtain a debt consolidation loan to lower their monthly payments on ‘current debts’.  Then, next Christmas when they are on a spending spree, they sign up for more store cards and run the debt up again.

Or, more blatantly, they take some of the debt consolidation money and go on a vacation, without repaying the loan. In the short run these may seem like the borrower is outsmarting the financial institution and getting some ‘free money’ but you are not playing with monopoly money.

The purpose of a debt consolidation loan, even a second mortgage, is to prevent bankruptcy. It is not free money. And, it is not an opportunity to extend a shopping spree or holiday. 

When used for its original purpose, a debt consolidation loan can help people restructure their finances, and help them out of a serious financial problem. Ask yourself a few questions before consolidating your loans.

Do You Need a Loan?

Your answer is probably yes.  Now, sit down and write out all your debts on a piece of paper.  Put a red line under all the ones that can be paid off in less than a year.  Put two red lines under credit cards and store cards.

This gives you a visual image of your loans. Now, cut up your credit cards.  Next, write down how much extra money you will have after the year is up, and after the credit cards are paid.

If you can repay all your debts within two years, than remortgaging is not a viable option, unless you can find a company that will let you have a second mortgage which you can repay early without paying an early repayment fee.

Credit Card Trap

Many people have two or three credit cards and store cards.  These bills are the source of their problem. The minimum payment doesn’t repay the capital, it just pays the interest. Many people pay a few hundred pounds off their credit card each year without ever touching the capital.

Unfortunately, a debt consolidation loan will not solve your credit card problems it only compounds them.

IVA

IVAs work well when used by the business community, but they fail miserably in the private sector.  The IVA garnishes your wages. All your wages, leaving very little for you to live on. If you try to work overtime, the IVA is automatically updated to the new income.  If you stop working overtime, the IVA is not instantly adjusted. This means that, until you readjust the IVA, your payments are in default – enter the default fees.

These ‘substantial’ default fees are attached to the end of the IVA term.  A few months of problems can extend an IVA for several months. 

The sign up fees, default fees, and high percentage of the client’s income garnished drive many people into bankruptcy.

It is also important to remember that you still have the 1 year bankruptcy period to wait after the IVA ends.

Debt Consolidation Loans

In many cases the debt consolidation loan is the best choice.  It may be secured against your home, but if you are looking at debt consolidation – instead of just paying your debts off – then your home is probably at risk already.

A debt consolidation loan will take several debts with high interest rates and pay them off with a lower interest loan.  The loan is often 2 – 5 years long, often comes with attractive early payment options.  This makes life easier by creating a win-win situation.