Archive for the 'Debt Consolidation' Category

Debt consolidation through a refinanced home loan can offer a tempting promise -- the exchange of your maxed-out credit cards for a clean slate. The trouble is, consolidating debt with a refinance doesn't reduce it by a cent. It just moves your balances to your mortgage lender.

Industry experts put the failure rate of debt consolidation programs as high as 80 percent. If you're part of the four out of five who take out these loans and don't pay them off, you could be worse off. The better you understand debt consolidation -- what it can do and what it can't do -- the less likely you'll make a bad financial move.

Understanding debt consolidation home loans

The critical thing to understand about consolidating your credit card debt with your home mortgage is that doing so extends the repayment period, which can greatly increase your overall interest paid. So a debt consolidation refinance could cost you a lot more, even if your interest rate is much lower.

Try this exercise with an online mortgage calculator and you'll see:

• If you have $10,000 of credit card debt at an interest rate of 15 percent annual percentage rate (APR), a typical payment of 3 percent of your balance equals $300. It would take you almost 18 years to pay it off and cost you $6,937 in interest.
• Let's say you take out a cash-out refinance at 5.5 percent to pay off your cards. The lower rate drops your monthly payment to $57, but you're spreading out your payments over years -- which increases your total interest cost to $10,440!

Of course, if you pay the same amount each month to aggressively chip away at your principal, the lower home loan rate will save you a bundle. But if you don't direct extra money toward your debt repayment, you'll pay more in the long run.

The best of intentions

I can hear it now: "Gina, if I consolidate my debt, I'll just pay it off faster! Then I will save money!" OK, I believe that you fully intend to do this. But people with credit problems may not be in the habit of denying themselves goodies. Know your own weaknesses: If not constrained by the terms of your loan, will you really make that extra payment, month after month, and not use your credit cards to buy things you don't earn enough to afford?

Give debt a one-two punch

Debt consolidation can work, of course, but it needs to be part of a total financial plan. Here's an example of how you might handle balances like the one above:

• Consolidate your credit card debt with a cash-out refinance at 5.5 percent.
• Instead of your old payment of $300, your new payment is $57. Put $100 a month into savings for emergencies (or a celebratory splurge… when you are debt-free, that is), then pay an extra $143 a month to pay interest and reduce the principal on your new mortgage.
• If spendthrift ways are at the root of your debt problem, close out your credit cards, keeping one for emergencies and for transactions that are very inconvenient without one (such as hotel reservations and car rentals). Don't carry the credit card with you if you're prone to impulse buys; use cash or a debit card instead.

If you follow this plan, guess what? Your $10,000 in credit card debt is paid off in four years and nine months, and you pay only $1,386 interest. Now that's a smart solution.

If you are managing your debt with credit counseling or a debt management plan, will that count against you in the mortgage qualifying process?

Credit counseling vs. debt management programs

Credit counseling alone -- that is, getting advice on budgeting and creating a plan for debt repayment -- can only have a good effect on your credit. The fact that you are being advised doesn't show up on your credit history, and reducing your credit card balances and paying on time improves your score.

However, some debt help firms put their clients in debt management plans (DMPs). DMPs work like this: You send the company a check each month, and they distribute the payment to all of your credit card companies. Many counselors don't just take your money and pay your creditors. They can arrange lower interest rates, smaller payments and perhaps even a balance reduction.

Debt management programs and your credit score

The fact that you're in a DMP may be reported to credit bureaus. From a credit history perspective, this may be good or it may be bad. Some creditors "re-age" a delinquent account after several successful on-time payments to show it as current on your credit report. Those actions can really help increase your FICO score.

If your debt management company negotiates concessions with your creditors, the way the creditor reports these concessions can lower your credit score.

According to its website, FICO looks at it this way: "Choosing to make partial payments or agreeing to settle for less than the full amount on accounts may be regarded negatively by the FICO® scoring model. Additionally, any late payments occurring either before or after you began the plan may also be regarded negatively."

Creditors may hit your credit history with derogatory codes such as "not paid as agreed" or "account settled for less than amount due." On the other hand, creditors may not report any concessions at all to credit bureaus. And once you have paid off your plan, it drops off your credit history.

Mortgage qualifying and DMPs

Mortgage underwriters have mixed feelings about DMPs. Some take your enrollment as an indication that you have credit problems and are therefore not a good risk. The FHA, for example, considers DMPs equal to Chapter 13 bankruptcies and requires you to have made at least 12 payments into your plan, on time, to become eligible for financing.

Others take the position that enrolling in a DMP is a responsible way to attack credit problems before they get out of control. Enrollment in a DMP may be simply ignored. Fannie Mae doesn't even mention DMPs or credit counseling in their guides.

Given the unknowns whether enrollment in a debt management program will affect your chances of qualifying, ask an experienced loan officer so there are no ugly surprises when you apply for your next mortgage.

Debt settlement, debt management, and debt consolidation firms are taking great pains to induce you to call them. They are bombarding the radio and TV with advertising geared towards consumers who are being consumed by credit card debt. They stuff your mailbox with fliers and brochures designed with the desperate in mind. And they flood your email with more ads than Pakistani "Viagra" sellers.

These firms promise to reduce your credit card debt and help you avoid or clean up your bad credit. The more reputable of these firms are able to accomplish what they promise, but others collect an up front fee for services and leave you in worst shape than you were in before.

The upfront fees for some debt settlement practitioners can exceed 20% of the total outstanding debt! A good bankruptcy lawyer is far less expensive and can accomplish the same sort of negotiation. Furthermore, bankruptcy attorneys are highly-regulated, and any money deposited with them must be escrowed and accounted for, unlike some fly-by-night debt donkeys.

A number of debt settlement, management, and consolidation companies are being sued by the Attorneys General of Illinois and other states. Illinois is crafting regulations to regulate the industry. The SEC is also getting involved, working on regulations that will make it illegal for firms to charge in advance for performing services like mortgage modifications. The new Illinois legislation being proposed will no longer allow debt consolidation companies to charge an up front fee for their services.

Other states, including North Carolina and Montana, have also issued warnings to their residents about debt consolidation companies charging up front fees.

But you don't have to wait for these practices to become illegal, and it shouldn't matter what state you live in. Simply refuse to work with any company that wants your money before performing any services. Or use a lawyer with a good track record. Your local Bar Association should be able to point you in the right direction.

People who never had to worry about bad credit in the past are worrying about it now. If the economy dealt you a bankruptcy, foreclosure, debt settlement, or a slew of late payments and collection accounts, you probably want to know how long it will take to recover and have good credit again. The answer? It depends.

The problem is that making a payment on time doesn't add as many points as making it late subtracts. FICO estimates that a single late payment can drop a score by up to 80 points if you have a score of 680. Bankruptcy drops it by 130. The good news is that your more recent history is weighted heavily; your distant past is not. So even though a bankruptcy can remain on your credit report for ten years, after three or four it loses its importance.

Gina's credit cleanup plan goes as follows:

1. Change your habits. If you have credit cards with balances, stop using them, stop carrying them, and start paying them off. Take the card with the lowest balance and pay more than the minimum -- as much more as you can. When it's gone, do the same with another card -- preferably the one with the highest interest rate. Your credit utilization (the amount of credit used versus credit available) will drop, and that can mean an improvement to 30% of your rating. Paying on time improves the payment history (35% of your rating). Try this for six months, then pull your credit report and see how much your score has improved.
2. Get professional help. If the reason you can't pay your debts is that your interest rates are too high, a non-profit, reputable debt management / credit counseling service and help you budget and perhaps negotiate lower interest rates from your creditors.
3. Become an authorized user. If you have family or friends with good credit, ask to be added as an authorized user on a credit account or two. You don't actually get or use the credit card (you don't even need to know the account number) but the history on that account will show up on your credit and become part of your credit score.
4. Try a secured credit card. This is a card designed to help you rebuild credit. The fee may be steep, and you'll have to deposit cash with the creditor in an amount up to the card's limit.Make sure that the creditor guarantees to report your payment history to credit bureaus -- and pay on time religiously.
5. Check your credit a couple of times a year. Make sure that your good behavior is being reported accurately. If you discharged accounts in a bankruptcy, make sure they show up that way on your credit report.
6. Know your time frames. If you want to apply for a mortgage, know that FHA will consider your application if at least three years have passed since a foreclosure, or two since a bankruptcy. You can even get a mortgage within one year of bankruptcy if your credit prior to filing was excellent and the filing was due to events beyond your control, such as a mass layoff at your company or a serious illness. If your credit was less damaged, try applying once you have successfully paid your bills on time for at least a year. If your only damage is a late payment or two, make payments on time for at least six months before applying for a new mortgage.

While it may seem that it takes a long time to clean up a credit history, remember that time is going to pass anyway. And three years from now you can be sitting on a good credit rating, or you can still be a problem child -- but three years older.

Okay, you're probably going to be glad to see 2009 go. You lost income. You gained debt. Cutting out lattes ain't going to cut it when it comes to debt relief. You want to start the new year by getting a handle on your debt. You could be good in the future if you could just get the past off your back--right?
Well, you can. It's won't be easy, but it can be possible. I'm gonna show you a couple of debt solutions that are similar but have some pretty important differences. I'm talking about debt management plans and Chapter 13 bankruptcies.

Chapter 13 Bankruptcy IS a Debt Management Plan

All debt management plans involve you making a single monthly payment to a third party, and that party making multiple payments to your creditors. The idea is that the single payment is supposed to be a lot smaller than the total of all the debt payments, and this is supposed to make it easier for you to manage your debts--hence the name, debt management. The main difference between the two is HOW the decrease in your monthly payment is achieved.

Debt management plans start with the creditors. Your credit counselor goes to your creditors and tries to negotiate lower payments, interest rates, and maybe even lower balances. Then you are given a total payment that you pay the credit counselor each month, which can be up to 40% lower than the total of all of your monthly obligations.

Debt Management Pros

• You minimize credit score damage.
• You could pay less interest.
• Your balances might be lowered.
• One payment simplifies bill-paying.

Debt Management Cons

• Agency fees may chew up savings.
• Forgiven balances are taxable.
• There may be amounts due when the plan ends.
• Debt consolidation mortgages may result in mortgage foreclosure.
• The plan may not be affordable.
• Creditor participation is voluntary.

The main thing to remember with a debt management plan is that the creditors run the show. Make sure that the payment is something you can afford. And if a debt consolidation loan secured by your home is involved, be very very sure that you won't get in over your head--or you'll be taking home equity that could be protected in a bankruptcy and giving it to the unsecured creditors who could be blown off in a bankruptcy. The best case outcome of debt management is that you pay off all of your debt within a few years and experience little or no damage to your credit rating.

Chapter 13 Bankruptcy--The Court-ordered Debt Management Plan

Chapter 13 bankruptcy is administered by a bankruptcy trustee. You make your monthly payment, which is distributed to your creditors as ordered by the court. At the end your your term, usually three to five years, any remaining balances are discharged for good.

Chapter 13 starts with you. A bankruptcy judge looks at your financial position, determines how much you need for reasonable living expenses, and subtracts it from your income after taxes to determine your monthly payment. Your creditors don't get to decide how much they want you to pay, and they don't get to opt out of the plan either--their participation is mandatory.

Chapter 13 Pros

• Debts such as back taxes can be discharged in addition to unsecured debts.
• You probably won't have to repay the entire balances.
• Forgiven debt is not taxable if done in bankruptcy proceedings.
• Creditors can't refuse to participate.
• The plan is created to be affordable to you.
• Creditors must stop charging interest and end collection efforts.
• Debts are wiped out on completion of the plan.

Chapter 13 Cons

• Your credit score may take a big hit.
• The filing is public record for ten years.
• It may make it harder to get jobs, insurance, or loans in the future.

Whatever solution you choose to blow away debt, get good help--no dirtbag lawyers working out of their garages, no sleazy credit counselors who want to help themselves, not you. Many smart people have been successful at debt reduction by trying credit counseling and debt management first and only opting for bankruptcy if they can't get an affordable plan.

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