Bankruptcy Alternatives / Debtor's Options

Debt Consolidation Loans
A Consumer's Debt Consolidation Loan FAQ

  1. The commercials on television make it sound like a debt consolidation loan will solve all my financial problems. Are these loans really the perfect way to solve my debt issues?

  1. For some people debt consolidation loans can work very well. For others they may come with disastrous side effects.

  1. How can I determine if a debt consolidation loan is right for me?

  1. Start by understanding what a debt consolidation loan is and how it fits into solving your personal debt situation.

  1. Isn't a debt consolidation loan just a loan where you get money to pay off your bills?

  1. No. In almost all cases a debt consolidation loan is structured as a second mortgage on your primary residence. Sometimes poeple with excellent credit can get an unsecured personal loan for their debt consolidation needs. For people with good fair or poor credit, unsecured personal debt consolidation loans may be harder to get and the maximum loan available hovers around $5,000-$15,000 depending on your exact credit and employment situation. In somes cases these loans do the trick, but for many debtors an unsecured debt consolidation loan of $15,000 or less does not address enough of their bills.

  1. What difference does that make?

  1. Most debtors attempting to obtain a debt consolidation loan face issues with unsecured debt, such as credit card bills. A second mortgage represents a secured debt. This becomes of critical importance if things go from bad to worse. With unsecured debt a chapter 7 bankruptcy can discharge the debt, completely relieving the individual of the obligation. In the case of secured debt, such as a second mortgage, even in a bankruptcy situation, the creditor has the right to seize the collateral if the loan cannot be repaid. When speaking about a second mortgage that would mean foreclosure on the property.

  1. I intend to make all my payments, why is this an issue?

  1. You may have taken the credit cards with the intention of paying off the balance each month as well. Good intentions are fine, but unexpected things happen in life. One of the most critical issues to analyze before taking on a debt consolidation loan will be the borrowers ability to weather a financial down turn. I recommend that anyone taking on a debt consolidation loan be very comfortable that should they have a health issue, loss of job or other unfortunate financial surprise that they would remain able to make the payment for some time on the new debt consolidation loan. To be even more clear, a debt consolidation loan means you "bet the house" that you can repay your credit card debt.

  1. My monthly payment with a debt consolidation loan will be much more affordable, what is wrong with that?

  1. There is nothing wrong with lower payments as long as you understand the mathematical reasons why the payments will be lower. Take a hard look at your current debt including the payments and the interest rates. How long would it take to pay off the debt in full? Then look at the terms of the debt consolidation loan. In some cases lower payments result from a significantly reduced interest rate, in other cases the reduced payment can come entirely from extending the payoff time to as long as 30 years.

  1. Aren't the rates of these debt consolidation loans always low?

  1. Absolutely not. In some cases, where the borrower has good credit and a fair amount of equity in the home, rates can indeed be close to rates expected for a first mortgage. In other cases, particularly those with individuals with poor credit or in case of 125% LTV debt consolidation loans, rates can soar to over 18%. Depending on your current debt, rates for these debt consolidation loans can be higher than the interest rate on the pre-existing debt.

  1. What is 125% LTV loan all about?

  1. 125% LTV (Loan To Value) loans allow the individual to borrow monies beyond the value of their home. For example if a home is worth $100,000.00 and the mortgage debt on the house is also $100,000.00, a 125% LTV loan would allow the debtor to borrow an additional $25,000.00 with the result being the total debt secured by the house after the loan would be 125% of the value of the home. While this type of loan opens the door for some individuals who may otherwise have no access to money it comes with a price. The interest rates for these loans typically run much higher that other mortgage loans and origination fees to set the loan up can be as much as 10% of the loan balance.

  1. Can anyone get a 125% loan if they need it?

  1. No. Only those with good to excellent credit will be eligible.

  1. What if a debt consolidation loan would really cure all my problems? Are there any other dangers?

  1. Yes. The debtor must examine how the trouble began. One of the most common pitfalls and recipes for the worst of disasters happens when people take on a debt consolidation loan without rectifying the true cause of the debt. A typical situation would play out like this: Individuals get into debt trouble because they are living beyond their means and supporting their spending habits with credit cards. A debt consolidation loan seems to solve things by paying off the debts. Unfortunately, if the spending habits continue, the individuals find in another year or two they have run their credit cards up to the same levels or higher than they were before the debt consolidation loan. Only this time the equity in their house has all been used up by the debt consolidation loan. They are unable to pay either the new bills or the debt consolidation loan and bankruptcy and foreclosure becomes await them.

  1. What is the best way to avoid this scenario?

  1. Find out why the debt has truly accumulated. In a case of irresponsible use of credit cards, after paying off the credit cards with a debt consolidation loan, cut the credit cards up. If you need to have credit cards for rental cars, business trips or on-line purchases consider secured credit cards or debit cards. Spending on secured credit cards cannot exceed a limit based on the value of an accompanying savings account. Use of debit cards require you have money in an account in order to use the card.

  1. Is there a way to get a debt consolidation loan that does not require pledging your house as collateral or a way to get a debt consolidation loan if you do not own a house?

  1. No. You may be able to get an unsecured personal loan, but unsecured personal loans will always require good to excellent credit and come with interest rates even higher than debt consolidation loans. Some people may refer to an unsecured loan as a debt consolidation loan, but the typical advertising you see on television or in the newspaper for a debt consolidation loan refers to one secured by a second mortgage.

  1. Is there any legal difference between a debt consolidation loan and a home equity loan?

  1. Not in most cases. A debt consolidation loan in legal structure generally does not differ in any way from what one might call a home equity loan or a second mortgage loan.

  1. Ok, Mr. Doom and Gloom, are there any good points to a debt consolidation loan?

  1. Yes. When debt consolidation loans carry a low enough interest rate payments can be significantly reduced. Many people find making one payment can be much more convenient that making five or ten smaller payments. Even if not the best long term plan, in the short run longer amortizations available with debt consolidation loans can help with cash flow. In certain cases I think home equity lines of credit make a great tool for financial emergencies.

  1. I have very bad credit and no collateral, like a house or a car, what kind of debt consolidation loan is available for me.

  1. Other than borrowing from friends or family, if you have very bad credit and no collateral I know of no legitimate financial entity anywhere that will make you a loan. This is an important point to stress for two reasons. If you have very bad credit and no collateral don't bother spending a lot of time and effort trying to find a loan. I have been trying to find unsecured personal loans for clients with very bad credit for 10 years, only to find none. If anyone reading this knows of a legitimate loan I would be excited to hear about it. Based on my knowledge of financial institutions, their requirements and the default rate that would exists on such loans, I don't believe that anyone who did endeavor to make such loans would stay in business long. With that said, the second point to keep in mind is not to expend any money to anyone telling you they can obtain an unsecured loan for anyone with very bad credit. I have seen ads where people are attempting to sell lists or in some way taking an up front fee for find such a loan. In other related cases credit cards are offered enabling a credit line even with very bad credit, where in reality the application fees, annual fees and other miscellaneous fees result with the borrower essentially paying $250.00 for a $250.00 line of credit. A new trick gaining popularity are "payday loans" or auto "title loans" avoid them like the plague. The hidden interest rates on these loans can be 500% per year! If you have very bad credit and need money don't make things worse by falling prey to a scam.

  1. In this context what constitutes very bad credit.

  1. While each account and loan request may be judged on it's own circumstances, a bankruptcy within 2 years or a number of accounts over 120 days late would probably be viewed very negatively by someone examining a request for an unsecured personal loan.

  1. Are there cases where it's not a bad idea to pledge the house as collateral for a debt consolidation loan?

  1. Yes, I can envision some situations, particularly in state that offers very little in way of homestead exemptions for homeowners in bankruptcy. In some places the equity in ones home is significantly at risk whether a debt consolidation loan is taken out or not. When the writing is on the wall that a debtor will lose their home unless they can clean up some of their financial mess, a debt consolidation loan can be the tool to save a home.

  1. I heard that debt consolidation loans are tax deductible, is this true?

  1. In some cases depending on the cost basis of your home the interest portions may be tax deductible. Potential borrowers should check with their tax advisors to explore what portion, if any, would be tax deductible for them.

  1. If things get better can I pay off a debt consolidation loan early?

  1. In most cases there is no prepayment penalty with these loans, but read your documents carefully. Some loans will indeed penalize you an extra-prepayment penalty fee if you pay the loan early.


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Nothing contained herein should be construed to constitute advice for your personal circumstances. This is intended as a peripheral exposure to the various options available, but by no means is this a comprehensive or exhaustive analysis of the bankruptcy laws or their alternatives. Whether or not you should file a Chapter 7 bankruptcy, Chapter 13 bankruptcy, or any bankruptcy, will vary depending on your personal circumstances and should only be undertaken after careful consideration, analysis and after consultation with an attorney experienced with such matters. These pages may contain information and rules peculiar to the Commonwealth of Massachusetts.

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The most recent update of this page occured on 8/21/01.

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